www.frbsf.org/cdinvestments
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March 2010
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FEDERAL RESERVE BANK OF SAN FRANCISCO
CRA INVESTMENT
HANDBOOK
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CRA INVESTMENT HANDBOOK
Center for Community Development Investments
Federal Reserve Bank of San Francisco
www.frbsf.org/cdinvestments
Center Staff
Advisory Committee
Joy Hoffmann, FRBSF Group Vice President
Frank Altman, Community Reinvestment Fund
Scott Turner, Vice President
Jim Carr, National Community Reinvestment Coalition
John Olson, Senior Advisor
Prabal Chakrabarti, Federal Reserve Bank of Boston
David Erickson, Center Manager
Catherine Dolan, Wells Fargo Bank
Ian Galloway, Investment Associate
Andrew Kelman, Bank of America Securities
Judd Levy, New York State Housing Finance Agency
John Moon, Federal Reserve Board of Governors
Kirsten Moy, Aspen Institute
Mark Pinsky, Opportunity Finance Network
John Quigley, University of California, Berkeley
Benson Roberts, LISC
Clifford N. Rosenthal, NFCDCU
Ruth Salzman, Russell Berrie Foundation
Ellen Seidman, ShoreBank Corporation and
New America Foundation
Bob Taylor, Wells Fargo CDC
Kerwin Tesdell, Community Development Venture
Capital Alliance
CRA Investment Handbook
Table of Contents
Foreword
Thomas FitzGibbon, MB Financial................................................................. 4
Introduction
David Erickson, Federal Reserve Bank of San Francisco............................... 5
Tax Credit Investments
Low Income Housing Tax Credit.................................................................... 6
Historic Tax Credit.......................................................................................... 12
New Markets Tax Credit................................................................................. 15
Other Investment Vehicles
Targeted Mortgage-Backed Securities............................................................ 20
Community Development Venture Capital Investments................................. 24
Private Activity Bonds.................................................................................... 27
Certificate of Deposit Account Registry Service............................................ 29
Equity Equivalent Investments (EQ2s)........................................................... 30
Community Development Finance Programs
CDFI Fund’s Financial and Technical Assistance Programs.......................... 34
HOPE VI......................................................................................................... 36
HUD’s Section 8 Housing Program................................................................ 39
FHLBs’ Affordable Housing Program............................................................ 42
Tax Increment Financing................................................................................. 46
Charter School and Rural Investment Programs............................................. 49
Outstanding Institutions
50 Top Performing $1-10B Banks.................................................................. 54
Regulatory Resource
2009 Community Development Q&As........................................................... 57
CRA INVESTMENT HANDBOOK
Federal Reserve Bank of San Francisco
FOREWORD
Thomas FitzGibbon, MB Financial Bank
I
t is my pleasure to invite you to review, evaluate and use the information contained in
this guide to CRA-qualifying community development investment programs. You will find
many ideas articulated within these pages that will pique your interest and help to guide you
in the evaluation of CRA Investment Test Qualifying transactions.
Many of the investment vehicles are tried and true high-quality opportunities that have proven
to provide both a market-rate return, with definable risk parameters that meet credit quality
standards. Some investments may not provide market rate return, but when used in combination
with other bank products and services provide a blended rate of return that meets or exceeds
return thresholds for similarly rated transactions.
Included in this guide are a range of quality investment opportunities. Some are more sophisticated than others, reflecting the “innovative and complex” characteristics that add value to
the investment for the CRA Performance Evaluation. These transactions often involve certified
Community Development Financial Institution (CDFI) partnerships where the level of sophistication necessary to underwrite, evaluate, issue and manage the capital provides long term
confidence that the capital will achieve the objectives and meet the return hurdles that the bank
is seeking.
The CDFI industry has matured significantly in the past decade where it is now positioned to
help the banking industry identify opportunities to deliver capital through a variety of vehicles
including, but not limited to: New Markets Tax Credits, Low Income Housing Tax Credits,
Donation Tax Credits, Purchase, Sale and Security Agreements (PSSA is also known in some
circles as private placement debt), loan consortia that can qualify for either CRA Lending or
Investment Credit, direct equity in qualified Community Development Intermediaries (equity
equivalent investments), as well as Limited Partnerships that finance CRA-qualified activity to
name but a few.
In addition to the direct investment in the qualified vehicles that are listed above there have been
opportunities in the past to purchase CRA Investment Test qualifying mortgage-backed securities (targeted MBS) where the mortgages in the security meet the standard.
In order to find the right investment that meets your bank objectives, your institution will now
have easily-accessible investment information in the form of this handbook that can aid you in
delivering on your bank business and CRA objectives.
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INTRODUCTION
David Erickson, Federal Reserve Bank of San Francisco
T
he CRA Investment Handbook brings together resources and information for investors at
banks who are, in part, motivated by the Community Reinvestment Act of 1977 (CRA).
The substantial revisions of the CRA in 1994 added the Investment Test for larger
depository institutions. According to the CRA, a qualified investment is “a lawful investment,
deposit, membership share or grant that has as its primary purpose community development.”
Bank regulators evaluate the investment performance of large institutions using the following
criteria:
•
•
•
•
the dollar amount of qualified investments;
the innovativeness or complexity of qualified investments;
the responsiveness of qualified investments to credit and community development needs; and
the degree to which the qualified investments are not routinely provided by private investors.1
In the pages that follow, we have brief descriptions of the leading community development
investment vehicles. The list of investments described here is not exhaustive, but they are
the ones a CRA-motivated banker is most likely to encounter.2 In addition to descriptions of
various tax credits and other investments, we have brief overviews of some of the key government subsidy programs, such as Section 8 vouchers, that make many community development
investments economically viable.
This booklet is a starting place and we hope you search out more detailed sources. Many good
leads are cited in the footnotes of this publications. You might also keep an eye out for new
publications from high quality sources such as the Office of the Comptroller of the Currency
(OCC) and Novogradac & Company. We also provide a list of the banks between $1 and $10
billion in assets that have achieved the highest rating on their investment tests. We focus on
these banks since they do not have the massive resources of the very large banks and still set
the highest standards for their investing programs. Finally, we provide some excerpts from
the regulatory guidance that pertains to CRA investments. For a more comprehensive look at
the regulations, however, we urge you to visit the Federal Financial Institutions Examination
Council’s website.3 Also, if you have a specific question about your bank’s CRA performance,
or CRA investments, you should consult your regulator’s examination staff.
These articles were written by CRA bankers and investment professionals with expertise in a
particular vehicle.4 This publication is intended to be a living document; it will be updated as
the market and regulatory environments continue to evolve and change. We, therefore, hope to
hear from readers who have suggestions for future versions of this handbook.
1 Ryan Trammell, “Success on the Investment Test,” Community Investments Online, Federal Reserve Bank of San
Francisco. Available at: http://www.frbsf.org/publications/community/investments/0409/success.html.
2 These descriptions should not be considered as an endorsement of any particular investment strategy; they
are described here for informational purposes only.
3 Available at: http://www.ffiec.gov/cra/default.htm.
4
Special thanks to Patrick Davis, UC Berkeley; Thomas FitzGibbon, MB Financial; Andrew Kelman, Banc of
America Securities, LLC; Jonathan Kivell, United Bank; Lauren Lambie-Hanson, Massachusetts Institute of
Technology; Beth Lipson, Opportunity Finance Network; and Kerwin Tesdell, Community Development
Venture Capital Alliance.
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T
LOW INCOME HOUSING TAX CREDIT
he Low Income Housing Tax Credit (LIHTC) is a subsidy provided directly to developers who build or rehabilitate affordable housing units. The program was created as
part of the Tax Reform Act of 1986 and made a permanent part of Section 42 of the
Internal Revenue Code in 1993. LIHTCs are awarded to rental housing projects by state allocating authorities in every state, as well as the District of Columbia, Puerto Rico, and Guam.
Investing in LIHTCs reduces federal income tax liability dollar for dollar, meaning $100 in tax
credits reduce a $100 tax liability to zero. The majority of investors in LIHTCs are corporate
entities.1
As Table 1 shows, a tax credit is typically more beneficial than a tax deduction.
Table 1. Differences between Tax Credits and Tax
Deductions on Net Income of $1 Million
No Tax Credit/
No Deduction
Deduction
Tax Credit
$1,000,000
$1,000,000
$1,000,000
None
(300,000)
None
Taxable Income
1,000,000
700,000
1,000,000
Tax Liability
Tax at 40% tax rate
400,000
280,000
400,000
LIHTCs
None
None
(300,000)
Net Tax Liability
$400,000
$280,000
$100,000
Net income from
operations
Tax Deductions
Source: Enterprise Community Partners, “Introduction to Low-Income Housing Tax Credits: Structuring
a Project’s Limited Partner Equity,” available at www.enterprisecommunity.com/products_and_services/
downloads/lihtc_101_ppt_10-06.pdf.
How to Use LIHTCs
Owners of a project can use LIHTCs to offset their tax liability. Owners can include an individual, corporation, limited liability company or a limited partnership.2 When using LIHTCs to
finance a project, developers must ensure that a minimum number of affordable units are made
1 National Association of Housing and Redevelopment Officials, “Resources for Affordable Housing: Low-Income
Housing Tax Credit” (Washington: NAHRO, 2002), available at www.nahro.org/home/resource/credit.html.
2 Washington State Housing Finance Commission, “LIHTC Introductory Guide: FAQ” (Seattle: Housing Finance
Commission, 2009), available at www.wshfc.org/tax-credits/faq.htm.
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available for lower-income renters.3 The minimum qualifications for LIHTC eligibility are:
• 20% of the units are set aside for individuals who earn 50% of area median income
or below;
• 40% of the units are set aside for individuals who earn 60% of area median income
or below.4
Financial Structure of LIHTCs
As an investment option, LIHTCs are awarded to projects (that is, developers receive the
credits via the affiliated legal entity responsible for the development) and “sold” to investors.5
After being awarded an allocation of LIHTCs for a qualifying project, a developer may request
bids from investors to be the “LIHTC equity investor” in that project. The chart below shows
the change in median price per dollar of LIHTCs paid by investors over time.
Source: Ernst & Young, “Understanding the Dynamics IV: Housing Tax Credit Investment Performance,” p. 26, available at: www.ey.com/Global/assets.nsf/US/TCIAS_Understanding_Dynamics_
IV/$file/tcias_understanding_dynamics_IV.pdf.
In arranging the financing for a project, developers must calculate the total “Sources and
Uses” of funds. Table 2 shows a “4 percent” LIHTC transaction, for which a LIHTC investor
would “pay in” $6.4 million for the LIHTCs awarded to the project.
3 Maine State Housing Authority, “Development Programs: Low Income Housing Tax Credit Program” (Augusta:
State Housing Authority, 2009), available at www.mainehousing.org.
4 Affordable Housing Resource Center, “LIHTC Lexicon” (San Francisco: Novogradac and Company), available at
www.novoco.com/low_income_housing/resources/lexicon.php.
5 Washington State Housing Finance Commission, “LIHTC Introductory Guide.”
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Table 2. Sample 4 Percent LIHTC Transaction
Project Funding Sources
Tax-Exempt Bond Proceeds
$12,200,000
(63%)
LIHTC Equity (4% LIHTC)
6,400,000
(33%)
Subordinated Loan
800,000
(4%)
Total
$19,400,000
(100%)
Land
$3,000,000
(15%)
Construction
14,000,000
(72%)
Financing Fees
1,000,000
(5%)
Other “Soft” Costs (incl. developer fee)
1,400,000
(7%)
Total
$19,400,000
(100%)
Funding Uses
Source: DC Housing Finance Agency, UBS Securities, and Eichner and Norris, “Presentation to District of
Columbia Building Industry Association,” available at www.dchfa.org/images/MixedIncomeHousingPresentation1-19-07.pdf.
4 Percent Credits vs. 9 Percent Credits: Four percent credits are available for new construction or acquisition-rehabilitation projects that include LIHTCs as a source of funds as well as
other federal subsidies. Typically, projects are financed with 4 percent LIHTC equity, and taxexempt bonds (either private placement or negotiated sale) issued by a state or local finance
agency.
9 percent credits are also available for both new construction and acquisition-rehabilitation
projects. However, projects with 9 percent credits are ineligible for tax-exempt bond financing
or other federal subsidies. As a result, the interest rate on a 9 percent project is market rate. In
contrast, a 4 percent project receives a discounted (that is, tax-exempt) interest rate. Allocating
authorities award tax credit equity for 9 percent transactions on a competitive basis (via a
scored application), whereas transactions with 4 percent equity are awarded on a first-come,
first-served basis.
In the transaction in Table 2, the LIHTC equity composes 33 percent of total sources of
funds. The pricing on LIHTC equity is based on a project’s “eligible basis,” which is “generally
equal to the adjusted basis of the building, excluding land but including amenities and common
areas.”6
6 Affordable Housing Resource Center, “LIHTC Lexicon,” “LIHTC Lexicon” Novogradac & Company LLP, Affordable
Housing Resource Center. Retrieved from: http://www.novoco.com/low_income_housing/resources/lexicon.
php.
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Given that this is a 4 percent LIHTC transaction, the project is eligible for tax-exempt bond
financing, which results in a lower interest rate for the borrowing entity. In this transaction, a
subordinate loan (most likely originated by a city agency and paid from residual receipts from
the property) fills the gap in financing the project. That is, in the above example, $18.6 million
in proceeds is available from LIHTC equity and bond proceeds, which does not equal the $19.4
million in total uses for the project. As a result, the developer likely sought a “soft” second
mortgage from a city agency to fill the gap in financing the project. One noteworthy aspect of
the sources and uses in Table 2 is the developer’s lack of cash equity. As is typical in LIHTC
deals, developers put very little of their own cash into projects.
Total Credit Allocation: State agencies responsible for administering LIHTC programs are
capped for the total amount of credits awarded to affordable housing projects (both 4 percent
and 9 percent) in any given year. According to an LIHTC Introductory Guide, “The amount
of annual authority [of LIHTCs allocated] is based primarily on the per capita population of
the state.”7 For example, for a state with a population of five million that is allocated $1.95
per resident, per year in LIHTCs, the total credit available for that year would be $9,750,000
(5,000,000 x $1.95). “In addition to the per capita credit authority amount, the state may gain
additional authority from other sources. These sources include credits forfeited by unfinished
projects and excess credits from completed ones. The state may also receive additional credits
from a national pool composed of the unused credits of other states.”8 All state agencies overseeing LIHTC programs are required to maintain a Qualified Action Plan (QAP), which lays
out the criteria for the award of LIHTCs to projects (which are required to “apply” for credit
allocations).
LIHTC Investment Structures
Investing in LIHTCs can be done by “direct investment” or through the “equity syndication” model. In these two options, investors place equity into projects directly or via investment
funds and, in exchange, receive the tax credits annually, as well as a portion of the project (or
projects’) depreciation, amortization, and operating expenses. For investors in LIHTC projects,
the compliance period for the investment is 15 years, although investors claim all credits in 10
years (with equal amounts claimed per year).9
Direct Equity Model: In the direct equity model, investors partner directly with developers,
both in terms of funding and ownership of the legal entity performing the development. For
example, a Limited Partner (LP) investor in the structure below would be a 99.99 percent owner
of the LP entity performing the development, and the General Partner (GP) would be the developer or an affiliated entity.10
7 Washington State Housing Finance Commission, “LIHTC Introductory Guide.”
8 Ibid.
9 Catherine Such, “Low Income Housing Tax Credits” (Portland: Columbia Housing, March 2002), available at
www.frbsf.org/community/investments/lihtc.html.
10 Ibid.
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Source: National Equity Fund, “A Primer: The Low Income Housing Tax Credit,” available at www.ncbcapitalimpact.org/documents/aalLIHTCprimer.pdf.
Equity Syndication Model: In the equity syndication model, an investor partners with an
equity syndicator, a for-profit or nonprofit firm tasked with identifying eligible LIHTC projects
and placing investments on behalf of the investors in its funds. Companies (including financial
institutions) that do not have the capacity or expertise to analyze individual projects use this
model. Investors are primarily concerned with underwriting the full equity syndicators, and
secondarily concerned with project-level analysis.11
Source: National Equity Fund, “A Primer: The Low Income Housing Tax Credit,” available at www.ncbcapitalimpact.org/documents/aalLIHTCprimer.pdf.
LIHTC Risks
Investors considering the origination of a tax credit equity investment must be cognizant of
the risks posed by this type of project finance. One risk, for example, is the likelihood of cost
overruns during construction. This risk, however, is mitigated by contingency reserves for hard
11 National Equity Fund, “A Primer: The Low Income Housing Tax Credit,” available at www.ncbcapitalimpact.
org/documents/aalLIHTCprimer.pdf.
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costs. In addition, the cost-overrun risk is mitigated by the project sponsor (that is, the developer)
providing a tax credit indemnity to the LIHTC investor and by executing both a completion and
carry agreement.
Another risk for LIHTC investors is the failure of the project to meet the projected lease-up
schedule, which would disqualify it from meeting the tax credit investor’s pay-in schedule. This
risk is mitigated by the fact that LIHTC projects target individuals at 50 percent or 60 percent
of the area’s median income or below. They therefore have a “rent advantage” relative to units
at non-LIHTC projects. In addition, the supply of affordable housing in metropolitan areas is
typically lacking, making newly constructed or rehabilitated LIHTC units attractive to tenants.
Supporting CRA Objectives with LIHTCs
A LIHTC investment qualifies under the investment test of the Community Reinvestment
Act (CRA). Typically, CRA credit is given in the year the investment is made, although the
benefits from the investment last for the length of the operating partnership.12 Depository banks
may satisfy their CRA needs for given geographic assessment areas using LIHTCs as part of
their overall strategy for the CRA investment test.13
12 Such, “Low Income Housing Tax Credits.”
13 Novogradac, “Community Development Investments.”
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HISTORIC TAX CREDIT
T
he Historic Tax Credit (HTC) program is classified by the Internal Revenue Service
as the Rehabilitation Tax Credit and included in Section 47 of the Internal Revenue
Code.14 The HTC can be applied to older buildings constructed before 1936 (eligible for
10 percent HTC) and historic buildings, including those listed on either the National Register
of Historic Places or located in a “Registered Historic District” and certified as historically
significant. These buildings are eligible for 20 percent HTC.
The HTC program is administered by both the National Parks Service, which is part of
the U.S. Department of the Interior, and the IRS. According to the IRS guidelines, HTCs are
applied to “depreciable buildings,” which are defined as those that have commercial or residential rental purposes.15 The IRS revised the HTC program to its current structure following the
Tax Reform Act of 1986, which also created the Low Income Housing Tax Credit (LIHTC).
The HTC offers investors a dollar-for-dollar reduction in federal income tax liability, which
is similar to LIHTC and New Markets Tax Credits (NMTC). The HTC is the largest federal
program for rehabbing historic buildings (in terms of dollar volume). In 2005, the National
Parks Service approved 1,101 projects for the 20 percent HTC. The average development costs
for a project certified was $3.06 million.16 Table 1 shows the share of overall projects in each
building category.
Table 1. HTC Program Projects
Type of Project Rehabilitated
Percentage of
Overall Projects
Multi-Family Housing..................................... 46 percent
Other Commercial Buildings....................... 27 percent
Office Buildings................................................ 24 percent
Project Development
HTCs are awarded for development costs, Qualified Rehabilitation Expenditures (QREs),
incurred in rehabilitation. For investors underwriting an HTC investment, QREs include walls,
partitions, floors, ceilings, paneling, windows and doors, air conditioning and heating systems,
plumbing, chimneys, and fire escapes. The following costs are not QREs: land and building
acquisition, site work (including demolition, fencing, parking lots, landscaping), personal property (including furniture and appliances), and new building construction.
Financial Structure
14 Merrill F. Hoopengardner and David F. Schon, “Laying the Foundation: The Basic Tax Rules Governing HTCs.”
Presentation to National Historic Tax Credit Conference, Washington, DC, November 7, 2007.
15 Ibid, section 168(e).
16 Ibid.
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Unlike investments in Low Income Housing Tax Credits, returns for HTC investors are
derived from a project’s cash flow and the annual credit against federal income tax. Investors
generally claim the tax credit in the year in which the rehabilitated building has been placed in
service (for example, the year it is made available for rental office space for a commercial real
estate project). Figure 1 outlines the financial structure of an HTC.
Figure 1. Financial Structure of a Historic Tax Credit Transaction
A sample calculation for the valuation of HTCs (on a per credit basis) is shown in Table 2.
As the table indicates, an equity investor paying $0.98 per credit would pay in a total of $4.73
million for a total of $4.8 million in HTCs. However, investors include the project cash flow
they receive to calculate the internal rate of return for the project investment.
Table 2. Valuing an HTC
Qualified Rehabilitation Expenditures...........................$24,060,799
Credit Rate (percent)............................................................20 percent
Total Calculated Credit........................................................$4,812,160
Tax Credit Investor Allocation...........................................99.99 percent
Total Credit to Investors......................................................$4,811,679
Credit Price Per Each $1 of Credit....................................$0.98
Equity Contributions from HTC Investors.....................$4,727,474
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Supporting CRA Objectives with HTCs
HTCs present a unique investment opportunity for CRA credit under the investment test of
the CRA exam when combined with either LIHTCs or NMTC. In addition, states have adopted
complementary programs for historic preservation involving state tax credits. North Carolina,
for example, offers the following program:17
• 20 percent state tax credit for rehabilitation of income-producing certified historic structures. This credit is awarded to rehabilitations that qualify for the 20 percent federal tax
credit. The combination of the two credits can reduce the cost of certified rehabilitations
by 40 percent. For income-producing properties, the rehabilitation expense must exceed
the greater of the "adjusted basis" of the building or $5,000 within a 24-month period or
a 60-month period for phased projects. A phased-project rehabilitation consists of two
or more distinct stages of development. The adjusted basis of a building is its purchase
price plus the amount of previous capital improvements, less previous depreciation
deductions.
• 30 percent state tax credit for rehabilitation of non-income-producing certified historic
structures, including personal residences. Qualified rehabilitation expenses must exceed
$25,000 in a two-year period.
17 Self-Help, Inc, “Historic Tax Credits” Retrieved from: http://www.self-help.org/business-and-nonprofit-loans/
business-and-nonprofit-files/business-nonprofit-technical-assistance-resources/Historic.Tax.Credits.doc.
Retrieved on May 21, 2008.
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T
NEW MARKETS TAX CREDIT
he New Markets Tax Credit (NMTC) was created by a bipartisan coalition in Congress
near the end of President Bill Clinton’s second term in office. The program was designed
to encourage investment in low-income urban and rural areas—places that usually
cannot access capital as easily or cheaply as wealthier communities. Because lenders believe
these areas come with higher lending risk, many investors loan money and make investments
only in more affluent areas, or charge higher rates for capital to compensate for the perceived
additional risks. The NMTC pro­gram was designed to correct for this assumption by providing
tax incentives to those who invest in businesses and development projects in low-income areas.
Such investment spurs business creation and im­provement, creates jobs, and increases social
capital among residents. The NMTC program was made possible, in part, by the success of
the Low Income Housing Tax Credit program, the founding of the Community Development
Financial Institutions (CDFI) Fund within the Treasury Department in 1994, and advocacy and
policy work by community develop­ment advocates who later formed the New Markets Tax
Credit Coalition.18
Understanding New Market Tax Credits
The Allocation Process: The framework of the NMTC program is complex. The Treasury
Department’s CDFI Fund, investors, and businesses in low-income communities are connected
through intermedi­ary groups called community development entities (CDEs). A wide variety of
institutions have formed community development entities, including community development
corporations (CDCs) and other local nonprofits, CDFIs, small business investment companies,
real estate development companies, venture capital com­panies, insured depository institutions,
investment banks, and governmental entities. Community development entities also vary in
geographic scope. Some confine their activities to one locality, while others serve communi­ties
across the country. The CDFI Fund certifies CDEs and allocates tax credit authority to them
and, together with the Internal Revenue Service, monitors their investments to ensure their
compliance with NMTC restrictions.
Once designated as a CDE, an organization can apply for tax credit allocation authority.
Since 2003, the CDFI Fund has conducted annual competitions to award tax credit authority to
CDEs. Each CDE requests a certain amount of credits to allocate to investors, who in turn give
the CDE capital to invest in low-income communities. The CDEs’ applications are assessed
and scored in four categories: business strategy, capitalization strategy, management capacity,
and community impact. Each category is equally weighted with a maximum 25 points each,
but CDEs can earn up to 10 “priority points” if they have a track record of successful investments in disadvantaged businesses or communities, or if the CDE commits to making investments in unrelated entities. Allocations can be awarded to CDEs in any loca­tion so long as the
investments are made in qualifying low-income communities. Except for Gulf Op­portunity
18 P. Jefferson Armistead, “New Markets Tax Credits: Issues and Opportunities,” Report prepared for Pratt
Institute Center for Community and Environmental Development, (2005), available at http://www.prattcenter.
net/pubs/nmtc-report.pdf.
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Zone funds, which are restricted to areas affected by Hurricane Katrina, there are no quotas for
allocating NMTC funds to any states or regions, unlike the Low Income Housing Tax Credit
program, which has some similar features to the NMTC program.
The allocation process is very competitive. Each year, CDEs apply for a far greater amount
of tax credit allocation authority than the NMTC program is authorized to award. As shown in
Table 1, in the 2007 allocation process, CDE applicants requested $27.9 billion but only $3.9
billion was awarded.19 Each year, or “round” of applications, has seen similar results. Because
of the overwhelming demand for allocations, the CDFI Fund must be selective about which
groups to support. The sixth round of allocations was awarded in fall 2008, and $3.5 billion was
allocated. By the end of this round, the NMTC program distributed $19.5 billion of tax credit
allocation authority to CDEs.20 To continue the allocations in future years, Congress must reauthorize the program.
Table 1. Allocation Availability and Demand, Rounds 1 through 6
Application Round
Available Allocation Application Demand
(in billions) (in billions)
Round 1 (2001–2002)................................... $2.5 ......................................... $26.0
Round 2 (2003–2004)................................... $3.5.......................................... $30.4
Round 3 (2005)................................................ $2.0.......................................... $22.9
Round 4 (2006)................................................ $4.1.......................................... $28.4
Round 5 (2007)................................................ $3.9.......................................... $27.9
Round 6 (2008)................................................ $3.5.......................................... $21.3
Total.................................................................... $19.5........................................ $156.9
Sources: New Markets Tax Credit Coalition 2007, CDFI Fund 2008, internal CDFI Fund data
Making the Investments (Turning QEIs into QLICIs): The CDEs that are awarded tax credits
must allocate them within five years of the award. This is the second step of the NMTC administration process. The CDEs negotiate with investors to trade the tax credits for cash investment
in the CDE. In return, the investor receives a credit worth 39 percent of the investment made
in the CDE. The credit is a dollar-for-dollar reduction in tax liability, so it covers only taxes
owed to the federal government, and the value of the credit is spread over seven tax years. The
capital provided to the CDE is referred to as a “qualified equity investment,” or QEI. The CDE
uses the QEIs made by the investors to make “qualified low-income community investments,”
or QLICIs.
19 New Markets Tax Credit Coalition, “New Markets Tax Credits Progress Report 2007,” available at http://www.
newmarketstaxcreditcoalition.org/reportsETC/newfiles/2007%20NMTC%20Progress%20Report%20-%20
Final.pdf.
20 Government Accountability Office, “New Markets Tax Credit Appears to Increase Investment by Investors in
Low-Income Communities, but Opportunities Exist to Better Monitor Compliance,” Report number: GAO-07296: (2007), available at http://www.gao.gov/new.items/d07296.pdf.
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Qualified low-income community investments are generally made in the form of loans or
investments with better-than-market terms to businesses in low-income areas. There are four
types of eligible QLICIs: (1) loans to or investments in qualified active low-income community
business (QALICBs); (2) financial counseling and other services; (3) loans to or investments in
other CDEs, provided that those funds are in turn used to finance qualified active low-income
community business or finan­cial counseling and other services; and (4) purchase of qualifying
loans from other CDEs. The CDEs have one year from the time they receive the QEIs to invest
substantially all (generally 85 percent of the proceeds) as qualified low-income community
investments. The vast majority (more than 95 percent) of all qualified low-income community
investments have been made in the form of loans to or investments in qualified active lowincome community business, including both operating businesses and real estate developers.
NMTC Investment Structures: There are three main structures of NMTC investments. In the
simplest model, the direct investment structure, a single investor makes a QEI in a CDE and
that capital is passed down to a qualified active low-income community business, minus any
CDE fees such as legal expenses. This model, shown in Figure 1, accounts for about 46 percent
of all qualified low-income community investments made.21
Figure 1. Direct Investment Structure
Another type of investment model is the tiered equity investment structure (see Figure 2). In
this model, multiple investors partner to provide equity or loans. They use a pass-through entity
to combine the capital and make the QEI in a CDE. The pass-through entity is often managed
by the CDE. Each partner can with­draw his or her share of the initial investment after seven
years. In the meantime, the partners receive tax credits and returns on their investments. About
13 percent of all qualified low-income community investments have been made through a tiered
equity structure.22
21 Ibid.
22 Ibid.
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Figure 2. Tiered Equity Investment Structure
The third main model for NMTC investments is the tiered leveraged investment structure
(Figure 3), which makes up about 41 percent of qualified low-income community investments.23 In this structure, as shown in Figure 3, investors form an investor partnership, which
then borrows money from a lender, typically a bank, to make a larger QEI. After combining
their equity with the capital from the loan, the partnership then makes a QEI in a CDE.
In return for their qualified equity investments, the partners receive tax credits for 39 percent
of the full QEI made, including the capital provided by the lender. They may also receive some
return on the investment during the initial seven years. The lender is paid interest during the
first seven years, as the qualified low-income community business makes loan payments to
the CDE. For the investment to comply with NMTC restrictions, the lender cannot receive tax
credits, and it cannot receive principal payments until the end of the seven-year term.
23 Ibid.
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Figure 3. Tiered Leveraged Investment Structure
The tiered leveraged investment structure is attractive to investors because they are able to
claim the full amount of the tax credit, not just 39 percent of the investment they made, even
if the business fails or defaults on the loan. The arrangement is attractive to bankers because it
allows them to make investments with a lower loan-to-value ratio, thus carrying less risk.24 It
is also attrac­tive to the borrowers because, in most instances, most if not all of the investor’s
equity remains with the qualified active low-income community business at the end of the
seven-year period given that investor returns are generated through the value of the tax credit.
The tiered leveraged structure is becoming increasingly popular, though it can become complex
as multiple tiers of investors are added.25
Supporting CRA Objectives with NMTCs
To qualify for NMTC eligibility, projects involving CDEs must operate in census tracts
with a 20 percent poverty rate or tracts with a median household income that is 80 percent or
below of the state or metropolitan statistical area’s median household income.26 NMTC investments may receive favorable CRA consideration given this emphasis on serving low-income
communities.
24 Ibid.
25 Jeff Wells, “Case Study from Application to Construction: Lenders for Community Development Puts New
Markets Tax Credit to Work,” Community Development Investment Review, (2005), Federal Reserve Bank of
San Francisco, vol. 1, no. 1.
26 Federal Reserve Bank of Richmond, “New Markets Tax Credits” (Richmond, VA: Federal Reserve Bank, available
at www.richmondfed.org/community_affairs/topical_essays_and_resources/reports/newmarket.cfm.
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TARGETED MORTGAGE-BACKED SECURITIES
M
ortgage-backed securities (MBSs) are a popular vehicle among financial institutions
looking to invest in their own communities. Community Reinvestment Act (CRA)
officers and other bank investment officers appreciate the return and safety that MBSs
provide relative to other securities. They also appreciate that they are widely available compared
with other qualified investments. Moreover, bankers today find that CRA-qualified MBSs can
typically provide a respite from concerns over the disruptions facing the mortgage markets and
the questions surrounding the various mortgage products and underwriting standards.
For decades, mortgage-backed securities have played a crucial role in housing finance in
the United States, making financing available to home buyers at lower costs and facilitating the
availability of funds throughout the country. Investors include corporations, banks and thrifts,
insurance companies, and pension funds. MBSs are popular because they provide a number of
benefits to investors, including liquidity, yield, and capital management flexibility.
Understanding MBSs
An MBS has characteristics similar to a loan. When a bank purchases an MBS, it effectively lends money to the borrower/homeowner, who promises to pay interest and to repay the
principal. In essence, the purchase enables the lender to make more mortgage loans. MBSs are
known as fixed-income investments and represent an ownership interest in mortgage loans.
Other types of fixed-income bonds include U.S. government securities, municipal bonds,
corporate bonds, and federal agency (debt) securities.
To create MBSs, lenders originate mortgages and sell groups of similar mortgage loans to
organizations such as Freddie Mac and Fannie Mae, which then securitize them. Originators
use the cash they receive to provide additional mortgages in their communities. The resulting
MBSs carry a guarantee of timely payment of principal and interest to the investor and are
further backed by the mortgaged properties themselves. Some private institutions issue MBSs,
known as private-label mortgage securities, in contrast to agency mortgage securities issued
and/or guaranteed by Ginnie Mae, Freddie Mac, or Fannie Mae. Investors tend to favor agency
MBSs because of their stronger guarantees, better liquidity, and more favorable capital treatment. Accordingly, this description focuses on agency MBSs.
The agency MBS issuer or servicer collects monthly payments from homeowners and passes
through the principal and interest to investors. Thus, these pools are known as mortgage passthroughs. Most MBSs are backed by 30-year fixed-rate mortgages, but they can also be backed
by shorter-term fixed-rate mortgages or adjustable rate mortgages.
Liquidity: Historically, agency MBSs have been extremely liquid assets. Because of a large
amount of outstanding mortgage securities and investors, investors have been able to easily
buy, sell, or borrow against MBSs. The liquidity of MBSs is enhanced by the relative homogeneity of the underlying assets compared with corporate bonds (different issuers, industries and
credit) or municipal bonds (state issued, authority issued, revenue bond, etc.).
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Yield: Mortgage-backed securities offer attractive risk-return profiles. There are higher
yielding fixed-income investments in the marketplace, but they have greater credit risk. MBSs
have traditionally provided returns that exceed those of most other fixed-income securities with
comparable risk profiles.27 MBSs are often priced at higher yields than Treasury and corporate
bonds of comparable maturity and credit quality. In fact, the market for investors in CRAqualified MBSs has never been better. The recent credit crisis has resulted in record yields for
MBS relative to Treasurys, with CRA-qualified MBSs offering yields around 5.5 percent and
comparable Treasury yields of only 2.0 to 2.5 percent.28
Capital Management: For banks and thrifts, agency MBSs are considered bank-qualified
assets. They can be held in higher concentration than other assets. In addition, the risk-based
capital (RBC) treatment of agency MBSs is superior to that of corporate and many municipal
bonds. For example, depositories holding Ginnie Maes do not have to hold RBC against the
assets, and they must hold just 10 percent of the RBC requirement for Freddie and Fannie MBSs.
This contrasts with a 100 percent RBC requirement for corporate bonds and up to 50 percent for
municipal bonds. Finally, there is an active repurchase (“repo”) market for MBSs that enables
institutions to earn increased income from their investments by lending in the repo market.
Evaluating and Purchasing MBSs
Banks and other investors buy MBSs from securities dealers. New MBSs usually sell at
close to their face value. However, MBSs traded in the secondary market fluctuate in price as
interest rates change. When the price of an MBS is above or below its face value, it is said to
be selling at a premium or a discount, respectively. The price paid for an MBS is based on variables including interest rates, the coupon rate, type of mortgage backing the security, prepayment rates, and supply and demand.
MBSs issued in book-entry form initially represent the unpaid principal amount of the mortgage loans.29 Freddie Mac and Fannie Mae MBSs issued in book-entry form are paid by wire
transfer through the central paying agent, the Federal Reserve Bank of New York, which wires
monthly payments to depository institutions. Depositories put the MBS in “held to maturity”
or “available for sale” accounts, depending on their investment strategy. Some investors hold
bonds until they mature, while others sell them prior to maturity. Buy-and-hold investors worry
about inflation, which makes today’s dollars worth less in the future.
Bank investment officers analyze the economic value of MBSs using a number of terms,
including weighted-average coupon (WAC), which is the weighted average of the mortgage
note rates, and weighted-average life (WAL), which is the average amount of time a dollar of
principal is invested in an MBS pool. The most important measure used by investment officers
to value investments is yield.
27 The Bond Market Association.
28 Bloomberg Yield Tables.
29 An electronic issuance and transfer system for securities transactions.
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Unlike other fixed-income investments, MBS principal payments are made monthly and
may vary owing to unscheduled prepayments (e.g., refinancing or sale of the mortgaged home),
which may also affect the amount and timing of MBS interest payments and MBS yields.
Prepayment assumptions are factored into price and yield to compare the value of a mortgage
security with other fixed-income investments.
As fixed-income securities, MBS prices fluctuate with changing interest rates: when interest
rates fall, prices rise, and vice versa. Interest rate movements also affect prepayment rates of
MBSs. When interest rates fall, homeowners refinance mortgages, and prepayment speeds accelerate. Conversely, rising rates tend to decrease the prepayment speed. An earlier-than-expected
return of principal increases the yield on securities purchased at a discount. However, when an
MBS is purchased at a premium, an earlier-than-expected return of principal reduces yield.
Each MBS has a coupon, which is the interest rate passed on to the investor. The coupon is
equal to the interest rate on the underlying mortgages in the pool minus the guarantee fee paid
to the agency and the fee paid to the servicer. The WAC is the weighted average of the mortgage note rates and investment officers often use it to compare MBSs. In analyzing a potential
MBS investment, the length of time until principal is returned is important and the concept of
a weighted-average life (WAL) is used. Average life is the average amount of time a dollar of
principal is invested in an MBS pool. The WAL is influenced by several factors, including the
actual rate of principal payments on the loans backing the MBS. When mortgage rates decline,
homeowners often prepay mortgages, which may result in an earlier-than expected return of
principal to an investor, reducing the average life of the investment. This can be thought of as
an implied call risk. Investors are then forced to reinvest the returned principal at lower interest
rates. Conversely, if mortgage rates rise, homeowners may prepay slower and investors may
find their principal committed longer than expected, which prevents them from reinvesting at
the higher prevailing rates. This scenario can be thought of as extension risk.
Supporting CRA Objectives with MBSs
The affordable housing goals that the U.S. Department of Housing and Urban Development
(HUD) set for Freddie and Fannie (e.g., 56 percent of their purchases in 2008 must be to borrowers
with incomes below the HUD median) help depository institutions achieve their LMI objectives
through agency MBS investments. Usually, MBSs are composed of loans scattered throughout the
country to borrowers with varying incomes. To support CRA objectives, affordable housing MBSs
are created with loans to LMI borrowers in specified geographies. As a “qualified investment,” the
MBS should include loans in an institution’s assessment area or in a statewide or regional area that
includes the assessment area. At least 51 percent of the dollars in the MBS should be in loans to
LMI borrowers, although in most cases the total is 100 percent. In addition, a financial institution
that has, considering its performance context, adequately addressed the community development
needs of its assessment area(s) will receive consideration for MBSs with loans located within a
broader statewide or regional area. As CRA documentation details, “Examiners will consider these
activities even if they will not benefit the institution’s assessment area(s).”30
30 Federal Financial Institutions Examination Council, “FFIEC Question and Answer Document on CRA.” This
document is available at the FFIEC website at the following link: http://www.ffiec.gov/CRA/default.htm.
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The Federal Financial Institutions Examination Council (FFIEC) issued an opinion letter
(no. 794) indicating that targeted MBSs may receive positive CRA consideration.31 This has
been reinforced by numerous CRA examinations. Moreover, as lending-related qualified investments, CRA-qualified MBSs assist small banks with their CRA performance by enabling an
upward adjustment of their loan-to-deposit ratio.
CRA-qualified MBSs increase the supply of affordable housing. MBS dealers pay a premium
to originators for the low- to median-income (LMI) loans they sell, giving originators an incentive to create additional LMI lending opportunities in communities, which is the essence of the
CRA. Banks that purchase MBS pools from dealers support this affordable housing initiative.
Reasons to consider MBSs as part of a CRA strategy include:
•
•
•
•
•
•
•
•
Payment of principal and interest is guaranteed
Market rate return
No management fees
Favorable capital treatment
Liquid investment: can be sold or borrowed against
Flexible: can be tailored to a bank’s assessment area and sold in varying amounts
Low transaction costs
Available everywhere, even in rural areas.
Investors increase the supply of financing for affordable housing through this product by
leveraging investment in affordable housing from nondepositories and by creating incentives
for loan originators. As with all CRA products, institutions should discuss their unique circumstances with their regulator, accountant, or tax adviser to determine suitability and accounting
treatment implications.
31 Federal Financial Institutions Examination Council, “Interagency Interpretive Letter, August 11, 1997.”
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COMMUNITY DEVELOPMENT VENTURE CAPITAL
E
quity capital is vital to small business development and growth. It makes possible
larger debt financings, and allows for rapid business expansion that cannot be financed
prudently with debt alone. Such companies as Apple Computer, Federal Express, and
Google all grew with the support of venture capital. Community development venture capital
(CDVC) funds provide this vital equity capital financing to businesses in underinvested communities in ways that promote entrepreneurship, wealth, and job creation. They seek market-rate
financial returns for their investors and create stronger economies where they invest. Banks and
other financial investors are finding CDVC funds to be a profitable way of both fulfilling their
obligations under the investment test of the Community Reinvestment Act (CRA) and helping
to build markets for their traditional business lending activities.
CDVC funds are relative newcomers to the family of community development financial
institutions (CDFIs). From only a handful ten years ago, there are now more than 70 CDVC
funds operating in both urban and rural areas of the nation, as well as dozens more in other
parts of the world. Capital under management in the United States has quintupled from $400
million in 2000 to more than $2 billion in 2009. (This data is based on Community Development Venture Capital Alliance data.)
The Importance of Banks and Other Financial Investors
The industry has changed rapidly during the past 10 years. Perhaps the greatest change is
the increasingly dominant role of financial institutions as investors. Foundations, government,
and other social investors provided early capital when the industry was still in an early stage.
While these social investors continue to be vital to the industry, the large amount of capital that
has fueled its recent rapid growth has come from banks and other financial institutions, such as
pension funds and insurance companies. Banks have accounted for more than 60 percent of new
capital raised by CDVC funds in the past five years, as compared with 40 percent of aggregate
capital raised by all CDVC funds in the past.
Raising capital for a new fund in today’s environment is challenging. Faced with market
and regulatory pressure to deleverage, banks have been reluctant to commit new capital to
CDVC funds, as they have been to most alternative investments. Funding from philanthropic
sources has dropped, as endowments have suffered losses and rates of giving and program
related investing (or PRI) have declined in reaction. At the same time, the level of interest in the
field of “impact investing” has skyrocketed in the past few years. The Obama administration,
too, has shown substantial interest in community development venture capital, and a new regulatory regime may increase incentives for banks and other newly-regulated financial institutions
to begin investing again, perhaps at higher levels than before.
CDVC funds have evolved to attract large amounts of capital from increasing numbers of
financially-oriented investors. Almost all new CDVC funds are adopting traditional market
structures: 10-year limited partnerships or LLCs with 2-3 percent management fees, and
incentivized management with a 20 percent carried interest going to fund managers and the
remaining 80 percent going to investors. Management teams are increasingly sophisticated,
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possessing both traditional venture capital and strong economic development experience. On
average, CDVC fund size, investment size, and geographic market scope have all increased
substantially, and a number of CDVC funds are moving to expansion-stage companies rather
than early-stage deals in response to investor feedback. Until the recent downturn, investors were
providing a vote of confidence by reinvesting in existing management teams: nine CDVC fund
management teams have successfully raised second and third funds, and more are in formation.
The model developed in the United States has been transported successfully to Western and
Eastern Europe, as well as the developing world. Investment Returns
CDVC funds target areas of the country where other venture capital funds tend not to look.
Most traditional venture capital investment dollars go to companies located in only five states—
California, Massachusetts, New York, Texas, and Colorado. Even in those states, investment
tends to be limited to certain distinct areas and to high-tech companies. CDVC funds focus on
urban and rural areas outside of the traditional venture capital funds’ typical stalking grounds.
This allows them to find deals others do not, keeping valuations reasonable and avoiding bidding
wars that suppress returns in overcrowded markets. In addition, many investors believe that—
because CDVC funds invest in different geographies and often in different types of deals than
typical venture capital funds—CDVC fund returns will behave differently than other investments in their portfolio, adding financial diversity. In fact, current anecdotal evidence indicates
that financial returns in the CDVC industry may outperform those in the traditional venture
capital industry during the current economic downturn.
Financial returns cannot be measured definitively until a venture capital fund has completed
a full investment cycle. It is said that venture capital portfolios can be valued accurately at only
two points: before any investments are made (when the fund has only cash) and after all investments are exited; at any point in between, valuation is highly speculative. Because the CDVC
industry is so new—the first traditionally structured 10-year partnership fund will not wind up
for several more years—we have no definitive return data on the CDVC industry equivalent to
the return-to-investor data published by the National Venture Capital Association.
However, in an effort to get an early answer to the important question of financial returns,
the Community Development Venture Capital Alliance (CDVCA) has compiled return information from a model portfolio composed of all exited investments made between 1972 and 1997
by the three oldest CDVC funds. All three had perpetual lives and primarily social investors,
and two were not-for-profit organizations. CDVCA looked at all of the 31 exits made during the
period, including seven full write-offs. Including these write-offs, the model portfolio yielded
a 15.5 percent internal rate of return—very much in line with the long-run return record of the
traditional venture capital industry. One would expect returns for the more recent, for-profit,
limited life funds to be higher, because of the increased pressure to achieve market returns
applied by investors and the pressure to exit quickly (which tends to boost returns) resulting
from the more recent funds’ limited lives.
CDVC funds achieve not only strong financial returns for investors, but also important
social impact for communities. Like most companies backed by venture capital, CDVC portfolio
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companies grow rapidly. A model portfolio of investments made by a number of CDVC funds,
for which CDVCA was able to gather job growth data, experienced employment increases of
169 percent annually. And these jobs are concentrated among lower-income people. A smaller
portfolio for which CDVCA was able to distinguish low-income employment showed an
employment increase of 89 percent, but with a 124 percent increase for low-income employees
as compared with a 37 percent increase for other types of employees. Most CDVC investments
are in LMI areas, and a high percentage are in government-designated empowerment zones,
new markets tax credit areas, and CDFI Fund hot zones.
How to Invest in a CDVC Fund
Unlike many CDFIs, CDVC funds are for-profit entities. They are usually organized as
limited partnerships (LPs) or limited liability companies (LLCs), and an investor in a CDVC
fund purchases a partnership or membership interest in the LP or LLC. Because capital is
invested in the form of equity rather than debt, the investor does not receive a set interest rate,
but rather return on investment is dependent on the success of the fund’s underlying investments in companies. Minimum investment sizes are typically in the hundreds of thousands of
dollars, but a bank investment in an individual fund is often in the millions.
While a CDVC fund typically has a life of 10 years, all capital committed to the fund
does not remain with the fund for the full 10-year period. At closing, a fund typically makes a
“capital call” for only a portion of the amount committed by investors. The fund will call the
additional committed capital over time to fund investments as they are made in companies.
When a fund exits an investment, it will typically distribute realized cash to investors, so the
investor receives its invested capital (plus associated earnings) back over time.
Supporting CRA Objectives with CDVC
Although investing in CDVC funds can be more complicated than other kinds of CRA
investments, the rewards can be substantial. First, a successful fund can provide financial
returns well above what a loan can offer. But more importantly, CDVC funds can be powerful
catalysts for economic growth in communities. Bankers know better than anyone else that
equity can be vital to the health and growth of a business. And along with equity capital, CDVC
funds provide substantial entrepreneurial and managerial expertise; they are active partners
in the businesses in which they invest. Equity capital and accompanying management expertise are rare commodities in low- and moderate-income areas, and are vital to their economic
growth. Finally, the equity capital that CDVC funds provide helps promote business formation
and expansion. A CDVC equity investment often makes possible much larger senior loans to
companies. CDVC funds therefore not only offer banks financial returns in their roles as investors, but also can be important long-term partners in a bank’s core lending business.
To find a CDVC fund in your area, you can visit CDVCA’s Web site at www.cdvca.org.
Leading CDVC funds across the nation are listed, along with fund profiles and profiles of representative deals. CDVCA operates a fund itself, which can accept capital in the form of grants
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M
PRIVATE ACTIVITY BONDS
unicipal bonds, which finance community development projects, are a common
investment vehicle for banks to earn Community Reinvestment Act (CRA) credit.
Known as Private Activity Bonds (PABs), these taxable or tax-exempt securities
allow state and municipal agencies to foster public-private partnerships.32 Other debt issuances
categorized as PABs include multifamily housing, industrial development, redevelopment, and
student loan bonds.33 The current formula is $80 multiplied by the state’s population, with a
per-state cap of $233,795,000 per annum.34
Project Finance
Bonds to finance community development projects can be either private placement or negotiated sale transactions. According to a recent journal article:
Private placements avoid many of the regulatory requirements of bonds sold through
typical competitive or negotiated sale mechanisms, because they are designed to be sold
directly to one (or to a very few) investor(s) who hold them until they mature (or are
redeemed). This creates potential opportunities for reducing the costs associated with
issuance and disclosure that make such sales a potential advantage, particularly in cases
where credit quality is poor or issue size is small.35
Negotiated sales allow for more liquid trading of bonds. However, they involve greater transaction costs, as those deals typically involve separate underwriters, trustees, bond purchasers, and
possibly financial guaranty insurance providers (as well as legal counsel for all organizations).
For bond purchases, either negotiated sale or private placement, investors underwrite both
the project-level metrics and the transaction’s sponsor. At the project level, bond investors are
concerned with the debt service coverage ratio (i.e., the ratio of project’s net operating income
to its annual debt service payment on its permanent mortgage) and loan-to-value ratio (i.e., the
ratio of amount of hard debt on a project to its appraised value). In addition, project-level details
that are relevant for underwriting include environmental history of the area, as well as information on the operating history and performance of a general contractor and property manager for
construction projects involving rental housing.
32 National Council of State Housing Agencies, “State HFA Factbook: NCSHA Annual Survey Results”
(Washington, DC: NCSHA, 2001).
33 National Council of State Housing Agencies, “Housing Bonds for Lower-Income First Time Buyers”
(Washington, DC: NCSHA, 2005), available at www.ncsha.org.
34 35 Ibid.
Mark Robinson and Bill Simonsen, “Why Do Issuers Privately Place Municipal Bonds?” Municipal Finance
Journal, vol. 27, no. 3 (Fall 2006), 15.
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In conducting financial analysis on the sponsor of a bond transaction, investors review the
organization’s liquidity and net worth. An investor’s goal in completing this due diligence is to
understand the sponsor’s ability to cover any cash flow shortfalls that may arise in operating a
project financed with bonds. For example, a bank that is considering a purchase of tax-exempt
bonds to finance a multifamily affordable housing project may set a minimum requirement of
cash-on-hand and net worth (adjusted for receivables that may not be converted to cash) for a
developer.
Supporting CRA Objectives with Bonds
PABs represent an opportunity for banks to lend or invest dollars in communities that are
included in their assessment areas for CRA exams. According to the Interagency Questions and
Answers on the CRA, “municipal bonds designed primarily to finance community development
generally are qualified investments. Municipal bonds or other securities with a primary purpose
of community development need not be housing related. For example, a bond to fund a community facility or park or to provide sewage services as part of a plan to redevelop a low-income
neighborhood is a qualified investment.”36
36 Federal Register, “Community Reinvestment Act: Interagency Questions and Answers Regarding Community
Reinvestments.” Federal Register, July 12, 2001, available at http://www.ffiec.gov/cra/pdf/qa01.pdf.
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T
CERTIFICATE OF DEPOSIT ACCOUNT
REGISTRY SERVICE
he Certificate of Deposit Account Registry Service (CDARS) is a depository product
that can be used for community development. CDARS is managed by the Promontory
Interfinancial Network LLC (Promontory), a Virginia-based firm founded in 2002 by
Eugene Ludwig, former Comptroller of the Currency of the United States.37
Participation in CDARS allows depositors to deal with a single financial institution while
still taking advantage of FDIC insurance on deposits exceeding the $100,000 limit. The CDARS
network spreads deposits among multiple banks to maximize FDIC protection. As of June 2008,
Promontory had more than 2,000 member banks in its network, and the CDARS service was
able to insure up to $50 million in deposits.38
One of the ancillary benefits of CDARS is that it increases deposits in member community
banks and other undercapitalized, community-based financial institutions, such as Community
Development Financial Institutions (CDFIs). In addition, “because banks swap deposits dollar
for dollar, all of the money deposited in a community development bank using CDARS goes to
work in the local community.”39
Supporting CRA Objectives with CDARS
Banks may earn CRA credit when making a deposit, through CDARS, in a community
development bank certified as a CDFI by the U.S. Treasury. According to the Office of the
Comptroller of the Currency, “Financial institutions can request that CDARS deposit funds in
participating banks that specialize in lending in low-income communities (in community development banks that are CDFI certified by the Treasury Department’s CDFI Fund).”40
37 Kelly Green, “Protecting Your Principal in IRA CDs,” Wall Street Journal, June 7, 2008, available at http://online.
wsj.com/article/SB121278609004552957.html?mod=googlenews_wsj.
38 Promontory Interfinancial Network, “About Promontory” Promontory Interfinancial Network (Arlington, VA:
Promontory, June 2008), available at www.promnetwork.com/about.html.
39 “Promontory Interfinancial Network and Community Development Bankers Association, “Initiative Promises
Financial ‘Win, Win, Win.’” Press release (Washington, DC, May 4, 2004), available at http://www.cdars.com/_
docs/news-articles/CDBA.PressRelease.pdf.
40 John Farrell and Denise Kirk-Murray, “This Just In…OCC's Districts Report on Investment Opportunities for
Banks,”Community Developments (Winter 2004/2005), available at www.occ.treas.gov/cdd/eZine/winter04/
thisjustin.html.
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A
EQUITY EQUIVALENT (EQ2)
INVESTMENTS41
strong permanent capital base is critical for community development financial institutions (CDFIs) because it increases the organization’s risk tolerance and lending flexibility, lowers the cost of capital, and protects lenders by providing a cushion against
losses in excess of loan loss reserves. It allows CDFIs to better meet the needs of their markets
by allowing them to engage in longer-term and riskier lending. A larger permanent capital base
also provides more incentive for potential investors to lend money to a CDFI. All of these results
help CDFIs grow their operations and solidify their positions as permanent institutions. Unlike
for profit corporations, which can raise equity by issuing stock, nonprofits must generally rely
on grants to build this base. Traditionally, nonprofit CDFIs have raised the equity capital they
need to support their lending and investing activities through capital grants from philanthropic
sources, or in some instances, through retained earnings. However, building a permanent capital
base through grants is a time-consuming process, and one that often generates relatively little
yield. It is also a strategy that is constrained by the limited availability of grant dollars.
Developing a Solution
In 1995, National Community Capital set out to create a new financial instrument that
would function like equity for nonprofit CDFIs. To realize this goal, National Community
Capital chose an experienced partner—Citibank—to help develop an equity equivalent that
would serve as a model for replication by other nonprofit CDFIs and to make a lead investment in National Community Capital. The equity equivalent investment product, or EQ2, was
developed through the Citibank/National Community Capital collaboration and provides a new
source and type of capital for CDFIs.
The Equity Equivalent - What is It?
The Equity Equivalent, or EQ2, is a capital product for community development financial
institutions and their investors. It is a financial tool that allows CDFIs to strengthen their capital
structures, leverage additional debt capital, and as a result, increase lending and investing in
economically disadvantaged communities. Since its creation in 1996, banks and other investors
have made more than $70 million in EQ2 investments and the EQ2 has become an increasingly
popular investment product with significant benefits for banks, CDFIs and economically disadvantaged communities. The EQ2 is defined by the six attributes listed below. All six characteristics must be present; without them, this financial instrument would be treated under current
bank regulatory requirements as simple subordinated debt.42
41 This article, written by Beth Lipson, originally appeared in Community Investments (Volume 14, Number 1,
March 2003) and is available at http://www.frbsf.org/publications/community/investments/cra02-2/index.
html. It is an adaptation of a National Community Capital technical assistance memo written by Laura Sparks.
42 Comptroller of the Currency, Administrator of National Banks, in an opinion letter dated January 23, 1997,
concerning Citibank’s Equity Equivalent investment in the National Community Capital Association.
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1. The equity equivalent is carried as an investment on the investor’s balance sheet in accordance with Generally Accepted Accounting Principles (GAAP)
2. It is a general obligation of the CDFI that is not secured by any of the CDFI’s assets
3. It is fully subordinated to the right of repayment of all of the CDFI’s other creditors
4. It does not give the investor the right to accelerate payment unless the CDFI ceases its
normal operations (i.e., changes its line of business)
5. It carries an interest rate that is not tied to any income received by the CDFI
6. It has a rolling term and therefore, an indeterminate maturity
Like permanent capital, EQ2 enhances a CDFI’s lending flexibility and increases its debt
capacity by protecting senior lenders from losses. Unlike permanent capital, the investment
must eventually be repaid and requires interest payments during its term, although at a rate
that is often well below market. The equity equivalent is very attractive because of its equitylike character, but it does not replace true equity or permanent capital as a source of financial
strength and independence. In for-profit finance, a similar investment might be structured as a
form of convertible preferred stock with a coupon.
Accounting Treatment
An investor should treat the equity equivalent as an investment on its balance sheet in
accordance with GAAP and can reflect it as an “other asset.” The CDFI should account for the
investment as an “other liability” and include a description of the investment’s unique characteristics in the notes to its financial statements. Some CDFIs have reflected it as “subordinated
debt” or as “equity equivalent.” For a CDFI’s senior lenders, an EQ2 investment functions like
equity because it is fully subordinate to their loans and does not allow for acceleration except
in very limited circumstances (i.e., material change in primary business activity, bankruptcy,
unapproved merger or consolidation).
CRA Treatment
On June 27, 1996, the OCC issued an opinion jointly with the Federal Deposit Insurance
Corporation, Office of Thrift Supervision, and the Federal Reserve Board that Citibank would
receive favorable consideration under CRA regulations for its equity equivalent investment in
National Community Capital. The OCC further stated that the equity equivalents would be a
qualified investment that bank examiners would consider under the investment test, or alternatively, under the lending test. In some circumstances Citibank could receive consideration for
part of the investment under the lending test and part under the investment test.43
This ruling has significant implications for banks interested in collaborating with nonprofit
CDFIs because it entitles them to receive leveraged credit under the more important CRA
lending test. The investing bank is entitled to claim a pro rata share of the incremental commu-
43 See the Resources section of National Community Capital’s website www.communitycapital.org for a copy of
the opinion letter.
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nity development loans made by the CDFI in which the bank has invested, provided these loans
benefit the bank’s assessment area(s) or a broader statewide or regional area that includes the
assessment area(s). The bank’s pro rata share of loans originated is equal to the percentage of
“equity” capital (the sum of permanent capital and equity equivalent investments) provided by
the bank.
For example, assuming a nonprofit CDFI has “equity” of $2 million—$1 million in the form
of permanent capital and $1 million in equity equivalents provided by a commercial bank—the
bank’s portion of the CDFI’s “equity” is 50 percent. Now assume that the CDFI uses this $2
million to borrow $8 million in senior debt. With its $10 million in capital under management,
the CDFI makes $7 million in community development loans over a two-year period. In this
example, the bank is entitled to claim its pro rata share of loans originated—50 percent or $3.5
million. Its $1 million investment results in $3.5 million in lending credit over two years. This
favorable CRA treatment provides another form of “return on investment” for a bank in addition to the financial return. The favorable CRA treatment is a motivating factor for many banks
to make an EQ2 investment.
Outcomes and Benefits
National Community Capital estimates that approximately $70 million in EQ2 investments
have been made by at least twenty banks, including national, regional and local banks. These
transactions have resulted in the following benefits:
EQ2 capital has made it easier for CDFIs to offer more responsive financing products. With
longer-term capital in the mix, CDFIs are finding they can offer new, more responsive products. Chicago Community Loan Fund, one of the first CDFIs to utilize EQ2, once had difficulty making the ten-year mini-permanent loans its borrowers needed. Instead, Chicago had
to finance these borrowers with seven-year loans. With over 15% of its capital in the form
of EQ2, Chicago can now routinely make ten-year loans and has even started to offer tenyear financing with automatic rollover clauses that effectively provide for a twenty-year term.
Cascadia Revolving Fund, a CDFI based in Seattle, finds EQ2 a good source of capital for
its quasi-equity financing and long-term, real estate-based lending, and Boston Community
Capital has used the EQ2 to help capitalize its venture fund.
Very favorable cost of capital. When National Community Capital first developed the equity
equivalent with Citibank, National Community Capital was uncertain about where the market
would price this kind of capital. The market rate for EQ2 capital seems to be between two to
four percent.
Standardized documentation for EQ2 investments. As EQ2 transactions become more common,
CDFI’s and banks have worked to standardize the documentation, thereby lowering transaction costs, reducing complexity and expediting closing procedures. There are good examples
of both short, concise EQ2 agreements and longer, more detailed agreements. Of particular
note are the loan agreements crafted by Boston Community Capital and US Bank. US Bank’s
three-page agreement, which succinctly lays out the investment terms and conditions, is a user
friendly document that has been used with approximately 25 CDFIs. The Boston Community Capital documents, with a 23-page loan agreement and a three-page promissory note, are
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substantially longer and more detailed, but include several statements and provisions that may
make a hesitant bank more likely to simply use the CDFI’s standard documents. For example,
the agreement specifically references the OCC opinion letter recognizing an EQ2 investment as
a qualified investment and includes a formal commitment from Boston Community Capital to
assist a bank investor with a Bank Enterprise Award application.44
Non-bank investors are beginning to utilize EQ2 investments. Although banks have a unique
incentive under the CRA to invest in equity equivalents, other investors can and are beginning
to use the tool as well. Chicago Community Loan Fund has secured an EQ2 from a foundation,
and Boston Community Capital has secured an EQ2 from a university. While the university and
foundation do not have the same CRA incentives, they are able to demonstrate leveraged impact
in their communities by making an EQ2 investment—rather than a loan—similar to how banks
claim leveraged lending test credit under CRA.
Bank Enterprise (BEA) Credit for EQ2 Investments
The CDFI Fund’s BEA program gives banks the opportunity to apply for a cash award for
investing in CDFIs. Banks typically receive a higher cash award (up to 15% of their investment)
for equity-like loans in CDFIs than for typical loans (up to 11% of investment). To classify as
an equity-like investment for the BEA program, EQ2 investments must meet certain characteristics, including having a minimum initial term of ten years, with a five year automatic rolling
feature (for an effective term of 15 years). The EQ2 must also meet other criteria, which are
described in the Fund’s Equity-Like Loan Guidance (available through the BEA page of the
Fund’s website: www.treas.gov/cdfi).
Conclusion
For CDFIs to grow and prosper, they will need to create more sophisticated financial products that recognize the different needs and motivations of their investors. The EQ2 is one step in
this direction. Unlike investors in conventional financial markets, CDFI investors (and particularly investors in nonprofit CDFIs) have few investment products to choose from. The form of
investment is typically a grant or a below-market senior loan. This new investment vehicle, the
EQ2, is one step in developing the financial markets infrastructure for CDFIs by creating a new
innovative product which is particularly responsive to one class of investors—banks. Further
development and innovation in CDFI financial markets will help increase access to and availability of capital for the industry.
44 The Bank Enterprise Award Program is a program of the CDFI Fund that provides incentives for banks to make
investments in CDFIs.
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T
FINANCIAL AND TECHNICAL
ASSISTANCE PROGRAMS
he Financial Assistance (FA) and Technical Assistance (TA) programs administered by
the Community Development Financial Institutions Fund (CDFI Fund) began in 1994
as a result of the Reigle Community Development and Regulatory Improvement Act.45
The FA and TA programs are two of the five programs the CDFI Fund oversees. The CDFI Fund
is an agency within the U.S. Treasury Department. As of December 2006, the CDFI Fund had
provided 667 FA awards totaling $524 million to qualifying organizations and 497 TA awards
totaling $24 million.46
The FA and TA programs provide cash awards to CDFIs for three main uses: (1) economic
development (including business development and commercial real estate development), (2)
affordable housing (including financing for homeownership and housing development), and (3)
consumer financial services (including financial literacy and basic banking services). The funds
are awarded directly to CDFIs as intermediaries, which then lend and invest funds in their local
communities. CDFIs leverage the FA funds awarded with other capital from foundations and
private financial institutions. The TA funds allow CDFIs to improve community services, help
borrowers expand their businesses, and strengthen their organizational capacity.47
Program Administration and Sample Awards
Applicants for FA and TA awards are CDFIs, which partner with banks, nonbank financial institutions, foundations, and other nonprofit organizations. For the FA program, CDFIs
apply to the CDFI Fund for up to $2 million.48 The funds are awarded annually, although 2009
included an additional round of awards for funds distributed through the American Recovery
and Reinvestment Act. The CDFI Fund scores applications on the basis of an applicant’s demonstrated ability to meet three goals: (1) provide affordable and appropriate financial products and
services that positively affect their communities; (2) be viable financial institutions; and (3) use
and leverage CDFI fund dollars effectively. CDFI applicants must match the funds awarded
through the FA program with nonfederal funds. Those sources of matching funds can include
below-market financing from banks, foundations, and nonbank financial institutions. The FA
award can also be provided to a CDFI as an equity investment, loan, deposit, or grant.49
45 Community Development Financial Institutions Fund, “CDFI Fund – U.S. Treasury – Community Development
Financial Institutions Program” (Washington, DC: CDFI Fund, 2009), available at www.cdfifund.gov/what_we_
do/programs_id.asp?programID=7.
46 Abt Associates, Inc., “Assessment of the Community Development Financial Institutions Fund (CDFI)
Program, Training Program, and CDFI Certification”. (Bethesda, MD: Abt, August 17, 2007), available at www.
cdfifund.gov/impact_we_make/Assessment/CDFIAssessmentFinal_Report.pdf. The figures do not account for
the nearly 300 awards to recipients of FA and TA funds.
47 L. Benjamin, S. Zielenbach, and J. Sass Rubin, “Community Development Financial Institutions: Current
Issues and Future Prospects,” Journal of Urban Affairs, 26 (2) (2004), available at www.federalreserve.gov/
communityaffairs/national/CA_Conf_SusCommDev/pdf/zeilenbachsean.pdf.
48 Ibid.
49 Community Development Financial Institutions Fund, “CDFI Fund.”
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For the TA program, both start-up and more experienced CDFIs may apply for funding to
support capacity building efforts to better serve their target markets. Among the qualifying uses
of TA awards are acquiring consulting services for market analysis, expanding information
technology capacity, providing training to the organization’s board or staff, or presenting educational programs to the target community served. A CDFI can apply for a maximum of $100,000
in TA funds, in addition to $2 million in FA funds. Unlike an FA award, an organization does
not need to match funding.50
As an example of a FA award, a California-based CDFI used the award to finance a charter
school facility in Los Angeles. The charter school building will support an additional 100
students as a result of the real estate project. In another example, a CDFI in Maine slated the $2
million for acquiring and rehabilitating residential housing units for low- and moderate-income
individuals and families.
Supporting CRA Objectives with Financial Assistance
and Technical Assistance Awards
To achieve their goals in accordance with the requirements of the Community Reinvestment Act
(CRA), banks have partnered with CDFIs in numerous ways. Banks have acted as investors, lenders,
and grantors to CDFIs that participate in CRA-qualifying activities. The Office of the Comptroller
of the Currency (OCC) lists the following options for banks to receive CRA recognition: 51
• Subordinated loan
• CD loan participation
• Certificate of deposit
• Grant contribution
• Stock or equity investments in a CD bank or CDFI (or its holding company)
• Involvement on an advisory board, credit review committee, or as a director
• Providing expertise, consulting, or training to lending staff
• Establishing correspondent banking relationship for loan business.
According to a 2006 OCC report, “A national bank may make an equity investment in a
CDFI or CD bank…This can help the investing bank expand its CRA reach into LMI [low- or
medium-income] areas or to LMI individuals within its assessment area—or in the broader
statewide or regional area—that it otherwise might have difficulty reaching. When a national
bank makes a qualified investment in a CDFI or a CD bank, it may receive positive CRA
consideration for its entire investment under the Investment Test, or it may choose to receive
CRA consideration for a pro rata portion of the loans and investments made by the CDFI or CD
bank.”52 Along with the CRA benefits, banks that partner with CDFIs may recognize expanding
market opportunities for consumer and commercial financing as well as positive effects on
community relations.
50 51 52 Ibid.
K. Tucker, “Expanding Your CRA Reach with CD Banks and CDFIs,” Community Developments (Washington,
DC: Office of the Comptroller of the Currency, online news articles, March 2006), available at www.occ.treas.
gov/cdd/Summer-08.pdf.
Ibid, p. 2.
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T
HOPE VI PROGRAM
he Hope VI Program began in 1992 as a federal government effort to redevelop public
housing. The program was initially called the Urban Revitalization Demonstration
program and was the result of findings from the National Commission on Severely
Distressed Public Housing.53 The study had found 86,000 public housing units nationwide to be
“severely distressed.” The commission’s recommendations focused on physical improvements,
management improvements, and providing social and community services for residents.54 The
HOPE VI program specifically focused on physical improvements in public housing units and
common areas, and social services for residents.
Since its inception in 1992, HOPE VI has provided more than $6 billion in funding for
the redevelopment of public housing units nationwide.55 The program funds the demolition of
existing public housing units, and the development of rental and for-sale housing units on the
same sites as the demolished buildings.56 The program has led to the redevelopment of more
than 63,000 housing units in more than 160 cities around the country.57
Program Administration
The program awards funding on a competitive basis. The U.S. Department of Housing and
Urban Development awards funds to Public Housing Authorities (PHAs), which work directly
with project developers.58 In designing a project that involves redeveloping public housing
units in a metropolitan area, a local PHA will collaborate with a developer on an application for
HOPE VI funds. Project financing often includes multiple sources along with HOPE VI. The
developer is responsible for approaching banks, nonbank financial institutions, and government
agencies for tax credit investments, tax-exempt bond purchases, traditional mortgage financing,
and subordinate loans for planned projects.
Project awards are often focused on developing units that are affordable for individuals and
families earning a range of incomes relative to the area’s median income. Given that one of the
goals of the HOPE VI program is to reduce the concentration of poverty in public housing sites,
developing mixed-income communities is given priority in funding decisions.59
53 S. Zielenbach, “Catalyzing Community Development: Hope VI and Neighborhood Revitalization,” Journal of
Affordable Housing, 13 (2) (Fall 2003), available at www.clpha.org/uploads/docs/Zielenbach-HOPE_VI___
Neighborhoods1.pdf.
54 U.S. Department of Housing and Urban Development, “HOPE VI: What is HOPE VI?” (Washington, DC: HUD,
HOPE VI, Public and Indian Housing), available at www.hud.gov/offices/pih/programs/ph/hope6.
55 U.S. Department of Housing and Urban Development, “About HOPE VI” (Washington DC: HUD, Public and
Indian Housing, DATE), available at www.hud.gov/offices/pih/programs/ph/hope6/about.
56 57 Zielenbach, “Catalyzing Community Development.”
Bruce Katz et al., “A Decade of HOPE VI: Research Findings and Policy Challenges.” (Washington, DC: Urban
Institute and Brookings Institution), available at www.urban.org/UploadedPDF/411002_HOPEVI.pdf.
58 D. Wood, “Public Housing: Information on the Financing, Oversight, and Effects of the HOPE VI Program.” Testimony
before the Subcommittee on Housing, Transportation and Community Development, Committee on Banking,
Housing, and Urban Affairs, U.S. Senate, June 20, 2007, available at www.gao.gov/new.items/d071025t.pdf.
59 Ibid.
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Financial Structure of HOPE VI
HOPE VI is one of many sources of funding for redeveloping public housing units. For
HOPE VI projects, sources of funding can include Low Income Housing Tax Credit (LIHTC)
equity, tax-exempt bonds, traditional bank debt, and subordinate debt or grants from state or
municipal agencies.60 Projects that use HOPE VI funds demolish existing multifamily apartment buildings and construct new rental or for-sale units that are lower density. Significant
government subsidies must be leveraged to meet the high per-unit development costs. For
example, as Table 1 shows, the Tremont Pointe project in Cleveland involved a HOPE VI grant,
a grant from the city, LIHTC equity, and a private mortgage.
Table 1. Sources of Funds for Tremont Pointe, Cleveland
Mortgage Debt.................................................................................... $2,116,000
Cuyahoga Housing Authority – Hope VI Award....................... $7,773,213
City of Cleveland................................................................................. $2,500,000
LIHTC Equity.......................................................................................... $5,700,000
Total Funds............................................................................................ $18,089,213
The resulting project is a mix of 190 for-sale and rental units offering community services to
residents. In addition, the project includes 3,000 square feet of community space and multiple
“green” amenities.61
A second example is the Henson Village project in Phoenix.62 Before the HOPE VI funds were
awarded, the Matthew Henson Homes had 372 housing units, 150 of which were constructed
in 1940. The redevelopment demolished 356 units, rehabilitated 16 units, and built 611 new
units. The mix of housing includes market-rate rental apartments and income-restricted rental
units (financed with LIHTC), market-rate and income-restricted for-sale units, retail commercial space, and community service areas.63
The North Beach Place project in San Francisco replaced 229 units of public housing with
341 new units affordable to a variety of families.64 The project was completed through a partnership of three development organizations and cost $108 million. Aside from the HOPE VI
grant, other sources of funds included 9 percent LIHTCs; an Affordable Housing Program grant
from the Federal Home Loan Bank of San Francisco; mortgage financing from a bank; funds
from the San Francisco Mayor’s Office of Housing and the San Francisco Housing Authority;
and developer equity.
60 Bruce Katz et al., “A Decade of HOPE VI: Research Findings and Policy Challenges.” (Washington, DC: Urban
Institute and Brookings Institution, May 2004), available at www.urban.org/UploadedPDF/411002_HOPEVI.pdf.
61 Green Communities, “Tremont Pointe, Cleveland” (Columbia, MD: Enterprise Community Partners), available
at www.greencommunitiesonline.org/projects/profiles/tremont_pointe.pdf.
62 City of Phoenix, “Matthew Henson: Hope VI Revitalization Project Information Sheet” Phoenix: City of
Phoenix, 2008), available at http://phoenix.gov/HOPEVI/hphenson.html.
63 64 Ibid.
Donna Kimura, “Grand Ideas Realized at North Beach Place,” Affordable Housing Finance (August 2005),
available at www.housingfinance.com/ahf/articles/2005/august/014_AHF_12-3.htm.
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Supporting CRA Objectives with HOPE VI
Because HOPE VI projects are typically located in low- and moderate-income neighborhoods and serve low- and moderate-income tenants and homebuyers, banks are able to earn
CRA credit for loans or investments originated for the projects. Banks eager to earn CRA credit
for working on HOPE VI projects would identify active projects via the local housing authority
or through affordable housing developers in the region.
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T
SECTION 8 PROGRAM
he Section 8 program, also known as the Housing Choice Voucher Program, is a federally funded program that provides housing payment subsidies to low- and moderateincome (LMI) individuals and families. The subsidy helps ensure that households
devote no more than 30 percent of household income to housing. Many LMI individuals and
families cannot easily find decent, affordable housing. The Section 8 program helps them pay
fair market rents that a landlord could otherwise receive. Approximately 1.4 million Americans
receive Section 8 subsidies.65
Program Administration
The Section 8 program is funded through the U.S. Department of Housing and Urban Development (HUD). Local Public Housing Authorities apply to HUD for funds to distribute to qualifying individuals and projects. LMI tenants apply directly to their local housing authority and
alert their prospective landlords of the secondary funding stream. Tenants receiving the Section
8 program pay 30 percent of their pre-tax income to the landlord. The local public housing
authority pays the landlord the difference between that amount and the fair market rent.66
The subsidy allows tenants to pay the fair market rents, avoid housing-induced poverty, and
still live in decent, affordable housing units. A recent study finds that Section 8 recipients are
less likely to live in economically and socially distressed neighborhoods. Approximately 15
percent of voucher recipients lived in high-poverty neighborhoods compared with more than
53.6 percent of public housing residents.67
The program offers two forms of payment: tenant based and project based. In a tenant-based
disbursal, the administering housing authority issues a voucher to the individual household,
which then finds a unit to rent. If the unit meets the Section 8 quality standards, the housing
authority pays the landlord the difference between 30 percent of the tenant's adjusted income
and the fair-market rent in the area (as determined by the housing authority).68
In a project-based disbursal, subsidies are not mobile. Rather, the subsidy is tied to a
specific unit for the term of a Housing Assistance Payments contract. The subsidy can be
used for newly constructed or rehabilitated units or for units in existing buildings. A projectbased subsidy effectively guarantees the developer, if the units are rented, a steady stream of
revenue that can help pay debts incurred during construction or rehabilitation. It also helps to
65 U.S. Department of Housing and Urban Development, “Housing Choice Voucher Program (Section 8)”
(Washington, DC: HUD), available at http://portal.hud.gov/portal/page/portal/HUD/topics/housing_choice_
voucher_program_section_8.
66 New York City Department of Housing Preservation and Development, “Residential Tenants: Section 8
Information” (New York: Department of Housing Preservation and Development), available at www.nyc.gov/
html/hpd/html/tenants/section_8.shtml#whatissection8.
67 M. A. Turner, S. Popkin, and M. Cunningham, “Section 8 Mobility and Neighborhood Health” (Washington,
DC: Urban Institute, 1999), available at www.urban.org/UploadedPDF/sec8_mobility.pdf.
68 HUD, “Housing Choice Voucher Program.”
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ensure that affordable housing is available to eligible households even when the rental housing
market is tight.69
Sample Section 8 Projects
Table 1 shows the 2006-2007 budget for the Wichita, Kansas, Housing Authority. Wichita has,
historically, administered approximately 2,500 Section 8 vouchers. However, the city reported
that it had approximately 1,500 people on its waiting list for affordable units as of 2006.70
Table 1. Wichita Housing Authority Budget,
Including Section 8 Vouchers
Program
Amount Allocated
Section 8...........................................................................................................$13,205,257
Public Housing.................................................................................................... 3,188,785
Community Development Block Grant..................................................... 2,931,400
HOME Funds........................................................................................................ 1,720,657
Emergency Shelter Grant................................................................................... 125,818
General Fund............................................................................................................. 25,000
Total....................................................................................................................$21,000,000
The Ashby Lofts Apartments in Berkeley are an example of a project-based Section 8
program. The 54-unit building cost $21 million to develop and was financed with Low Income
Housing Tax Credit equity, funds from the California Multifamily Housing Program, and other
sources. As a rental building, the project was awarded a project-based Section 8 contract for 20
units.71 Likewise, in the South Lake Union neighborhood of Seattle, the Low Income Housing
Institute developed 50 units of affordable rental housing in Denny Park Apartments. The project’s units are affordable for individuals and families with income levels at or below 60 percent
of the area’s median income, and 13 units will be set aside specifically for Section 8 tenants.72
Supporting CRA Objectives with Section 8
Because Section 8 is intended to make housing affordable to low- and moderate-income
individuals, loans and investments for Section 8-qualified projects have qualified financial insti-
69 Massachusetts Department of Housing and Economic Development, “Section 8 Project-Based Voucher
Program” (Boston: Department of Housing and Economic Development, 2009), available at www.mass.gov/?p
ageID=ehedterminal&L=3&L0=Home&L1=Housing+Development&L2=Rental+Assistance+Management&sid
=Ehed&b=terminalcontent&f=dhcd_factsheets_s8pbv&csid=Ehed.
70 Housing and Community Services of Wichita, “City Council Orientation” (Wichita: Housing and Community
Services Agency, April 2007), available at www.wichita.gov/NR/rdonlyres/7F6DA028-03D3-47CC-B79EBB11DC7390FF/0/HousingCommunityServices2007.pdf.
71 Housing and Community Services Department, “Recently Completed Affordable Housing Projects in
Berkeley” available at www.ci.berkeley.ca.us/ContentDisplay.aspx?id=10502.
72 Green Communities, “Denny Park, Seattle, Washington.” (Seattle: Green Communities and Enterprise and
the Natural Resources Defense Council), available at www.enterprisecommunity.org/partnership_programs/
green_communities/projects/profiles/DennyPark-2006.pdf.
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tutions for credit under the lending and investing tests of the Community Reinvestment Act
(CRA). In general, Section 8 properties typically serve LMI populations and are often located
in CRA-qualified geographic areas. Participation in financing arrangements for properties that
serve LMI individuals or LMI neighborhoods can earn recognition for banks in their CRA
efforts. In one sample CRA exam performance evaluation, the Office of the Comptroller of the
Currency noted the participation of the bank in two projects funded through Section 8:
The bank provided $2 million in financing to a borrower to acquire an 83-unit
apartment building for low-income tenants, in which the rents are subsidized
through the HUD Section 8 program. The building is located in a section of
Hollywood that is targeted for redevelopment…CNB provided $7.6 million in
financing to a company to acquire a 199-unit apartment building in Santa Ana.
The tenants are senior citizens and all rents are subsidized through the HUD
Section 8 program.73
73 Office of the Comptroller of the Currency, “Community Reinvestment Act Performance Evaluation: City
National Bank” (Washington, DC: OCC, January 10, 2000), p. 18, available at www.occ.gov/ftp/craeval/
jan01/14695.pdf.
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T
AFFORDABLE HOUSING PROGRAM
he Federal Home Loan Bank System’s Affordable Housing Program (AHP) began in
1989 as a directive from the Financial Institutions Reform, Recovery and Enforcement
Act (FIRREA).74 Each of the country’s 12 regional Federal Home Loan Banks (FHLBs)
administers an AHP program. The program subsidizes the development of for-sale and rental
housing units. The FIRREA regulation calls for each FHLB to set aside ten percent of its net
income for subsidized financing through AHP and the Community Investment Program. The
latter provides below-market financing for qualifying community development projects. Each
FHLB branch maintains a 15-member advisory council that provides insight and guidance on
community development issues, including affordable housing, in that respective region. The
councils help to ensure that projects awarded funds have substantial community development
goals.
Since 1990, AHP has contributed $3 billion in funds to affordable housing developments
around the country.75 According to the Council of Federal Home Loan Banks, the program is
“one of the largest private sources of grant funds for affordable housing in the United States.”76
AHP funds have helped finance approximately 623,000 housing units; of those, 391,000 units
have been set aside for residents who are considered very low-income.77
Program Administration
Affordable housing projects are awarded AHP funds through a competitive application
process. To receive AHP funds, FHLB member banks partner with affordable housing developers and community-based organizations to complete applications, which are submitted to
FHLB staff members for review. The applications are reviewed, and projects are funded, annually or bi-annually.78 Projects funded through AHP serve a wide range of neighborhood needs:
many are designed for seniors, the disabled, homeless families, first-time homeowners, and
others with limited resources.79
Funds awarded through AHP can be used to develop housing units for individuals and families whose income levels are at or below 80 percent of the area’s median income (AMI). In
presenting an AHP application, a developer will often mix the AHP award with other funding
sources, including tax-exempt bonds and Low Income Housing Tax Credits (LIHTC). For rental
housing projects funded through AHP, a minimum of 20 percent of the project’s units must be
74 Michael Swack, “Social Financing” in A Right to Housing Foundation for a New Social Agenda, edited by
Rachel G. Bratt et al. (Philadelphia: Temple University Press, 2006).
75 Council of Federal Home Loan Banks, “Affordable Housing Program” (Washington, DC: FHLBanks, A Nation of
Local Lenders, 2009), available at www.fhlbanks.com/programs_affordhousing.htm.
76 Ibid.
77 Ibid.
78 79 Federal Home Loan Bank of Dallas, “Community Investment: Affordable Housing Program” (Dallas: 2005),
available at www.fhlb.com/community/ahp.
Council of Federal Home Loan Banks, “Affordable Housing Program.”
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affordable for individuals or families earning 50 percent or less of the AMI. 80 This requirement
is similar to the LIHTC stipulation that 20 percent of the units serve individuals with incomes
at or below 50 percent of AMI or 40 percent of the units serve individuals whose incomes are
at or below 60 percent of AMI. In addition to funding a project’s construction costs, AHP funds
may also be used to lower the interest rate on loans or cover down payment and closing costs
for projects.
According to the Federal Home Loan Bank of Pittsburgh, AHP provides grants and loans
for single- and multifamily housing; new construction and rehabilitation; rental and owner-occupied homes; scattered-site housing development projects; and transitional and single-roomoccupancy housing.81 The developer of a project assists the sponsoring financial institution in
completing the application for funds, which the respective FHLB Community Development
staff review. The Federal Home Loan Bank of New York lists the following as scoring criteria
for AHP applications:82
•
•
•
•
•
•
•
•
•
Donated properties
Sponsorship by nonprofit or government entity
Targeting
Homeless housing
Empowerment
Community stability
First district priority: economic diversity and community strategies
Second district priority: moderate-income rental housing
AHP subsidy per unit
Financial Structure of the Affordable Housing Program
Subsidies in addition to AHP include LIHTC, tax-exempt bonds, and Community Development Block Grants (CDBG). Table 1 shows how a grant of $200,000 from the FHLB of
Atlanta was combined with numerous other sources of funds to develop a 112-unit project in
Williamsburg, VA.83
80 Federal Home Loan Bank of Indianapolis, “FHLBI Implementation Plan” (Indianapolis: 2009), available at
www.fhlbi.com/HOUSING/documents/A.pdf.
81 Federal Home Loan Bank of Pittsburgh, “Affordable Housing Program, 2009: AHP Information” (Pittsburgh:
FHLBank, Housing and Community Programs, 2009), available at http://www.fhlb-pgh.com/housing-andcommunity/programs/affordable-housing-program.html.
82 Federal Home Loan Bank of New York, “Using Affordable Housing Program Subsidies to Supplement
Financing for Low-Income Housing Tax Credit Projects.” (Trenton: State of New Jersey Housing and Mortgage
Finance Agency website: Low Income Housing Tax Credits, n.d.), available at www.nj.gov/dca/hmfa/biz/devel/
lowinc/FHLB percent203-11-08.ppt.
83 Community Housing Partners, “Preserving Rural Housing Development Properties Using LIHTC.” Presentation
to Virginia Housing Preservation Symposium, June 18, 2008, available at http://vacommunitycapital.org/
products/documents/CHP-OrlandoArtze.pdf.
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Table 1. Lafayette Village Family Apartments: Sources and Uses
Sources
VHDA: REACH
VHDA: FLEX
VHDA: Taxable
RD #1: Orig. Loan
DHCD: HOME
FHLB-Atl.: AHP
Tax Credit Equity
Deferred Developer’s Fee
Total
Uses
$950,000
$185,000
$120,000
$4,151,916
$195,000
$200,000
$5,133,774
$440,739
Hard Costs
Soft Costs
Developer Fee
Acquisition Cost
$11,376,429
$3785,488
$1,358,056
$1,000,000
$5,232,885
Total
$11,376,429
Given that the AHP awards subsidize only a small percentage of a project’s total costs, developers leverage other federal, state, and local programs to finance affordable housing projects. In
the above example, a developer used LIHTC equity to finance the property and also won an AHP
award.84 The AHP award helped fill the gap between the project’s total development costs and
the amount that could be financed through traditional sources, grants, and subordinate loans.
In another sample project in 2009, the Federal Home Loan Bank of Dallas awarded $280,000
to Tohatchi Area Opportunity Services, Inc., a nonprofit organization in New Mexico. First
Community Bank was the bank sponsor for this AHP award, which helped fund 40 homeownership units.85
In 2009, the Federal Home Loan Bank of San Francisco awarded AHP funds to the Pierce
Street Villas Phase 3 project. The developer, Habitat for Humanity of San Fernando and Santa
Clarita Valley, used the $360,000 AHP award to finance a 24-unit homeownership project. Bank
of the West was the sponsoring bank and submitted the AHP application to the Federal Home
Loan Bank of San Francisco.86 The units in this project are reserved for families with incomes
at or below 60 percent of the AMI for Los Angeles County.
Supporting CRA Objectives with AHP
Banks that are members of a Federal Home Loan Bank can achieve their Community
Reinvestment Act goals by participating in the AHP. In 2006, the FDIC provided a list of
community development services recognized under CRA, including the AHP.87 In addition,
bank regulatory agencies published the following guidance on CRA and AHP in the January
84 Federal Home Loan Bank of New York “Using Affordable Housing Program Subsidies.”
85 Federal Home Loan Bank of Dallas “Community Investment.”
86 Federal Home Loan Bank of San Francisco, “2009 Round A Affordable Housing Program Award Recipients”
(San Francisco: FHLB website), available at http://www.fhlbsf.com/ci/grant/ahp/pdf/09A_Awards.pdf.
87 “FDIC: Press Releases – PR-23-2006 03/02/2006” Federal Deposit Insurance Corporation. 2006. Retrived from:
http://www.fdic.gov/news/news/press/2006/pr06023a.html.
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2009 Federal Register:
The Q&A continues to point out that institutions’ other activities in connection with the
FHLBs’ AHP program would be considered in an institution’s CRA evaluation—for
example, providing technical assistance to applicants would be considered as a community development service…88
For one sample CRA exam performance evaluation, the Office of the Comptroller of the
Currency noted the participation of the bank in AHP activities:
Bank employees also provided technical assistance to the Cleveland community by
submitting Affordable Housing Program applications to the Cincinnati Federal Home
Loan Bank. Specifically, the bank assisted in filing nine applications which totaled $5.3
million.89
88 “CRA Interagency Questions and Answers.” Notices. Federal Register, 74 (3) (January 6, 2009), 503, available at
http://edocket.access.gpo.gov/2009/pdf/E8-31116.pdf.
89 Office of the Comptroller of the Currency, “Community Reinvestment Act Performance Evaluation: KeyBank,
N.A.” (Washington, DC: OCC, July 1, 2008), 19, available at http://www.occ.gov/ftp/craeval/Sept09/14761.pdf.
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T
TAX INCREMENT FINANCE
ax Increment Finance (TIF) began in California in 1952, and 49 states have passed TIFauthorizing legislation since then.90 The goal of TIF is to provide a financing mechanism for infrastructure and real estate improvements needed for economic development
in targeted areas within cities and states.91 TIF-financed projects and districts are often located
in low- and moderate-income communities. Map 1 shows the historic breakdown of TIF-authorizing legislation by state as of 2007.92
Map 1. History of TIF Legislation by State
Years Approved
1990 – Present Day
1970 – 1989
1950 – 1969
No TIF Law
Using TIF funds allows a metropolitan area to effectively freeze the amount of tax revenues
that the municipal government will receive from a district or specific property. This baseline
can be applied to sales tax, property tax, or both. To stimulate economic activity in the TIFdesignated area, the government then allows real estate developers, local businesses, or city
90 91 92 J. Y. Man, “Introduction,” in Tax Increment Financing and Economic Development (Albany: State University of
New York Press, 2001).
Ibid.
Council of Development Finance Agencies and the International Council of Shopping Centers, “Tax
Increment Finance Best Practices Reference Guide” (New York: CDFA, 2007), available at www.mrsc.org/
ArtDocMisc/CDFA.pdf.
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agencies to borrow funds against the future increases in tax revenues generated by that region
as commercial activity grows. That “tax increment” is used to pay debt service for the debt
holders.93
Program Administration and Examples
In implementing a TIF district, typically a city redevelopment agency identifies an area that
is lagging the rest of the city in its economic development capacity. Issuing notes to finance the
development of this area allows the city to effectively borrow against future tax revenues the
district will generate. The commercial development of the TIF district then provides cash flow
in the form of sales and property taxes to service the debt on TIF notes. TIF districts can help
provide financial incentives to redevelop dilapidated buildings, remediate brownfield sites, and
improve infrastructure such as roads or sewer systems.94
TIF programs are administered at the local level, with redevelopment agencies or other
city agencies overseeing their operations. In Oakland, for example, the city’s Community and
Economic Development Agency identified ten districts slated for redevelopment with TIF
funds.95 In Portland, Oregon, the Portland Development Commission uses TIF financing to
encourage private-sector investment, increase the number of jobs in the city, and expand the
city’s tax base. This city agency has created 11 districts that are funded through TIF.96
Supporting Community Reinvestment Act Objectives with TIF
In TIF transactions, banks purchase TIF-district bonds, which municipal agencies issue. The
federal banking regulatory agencies have not identified specific implications of tax-increment
finance on a bank’s Community Reinvestment Act (CRA) performance. However, because TIF
transactions often involve low- and moderate-income census tracts and businesses serving lowand moderate-income individuals, banks providing tax-increment financing would be considered eligible for earning CRA credit for those efforts. The following statements, which highlight TIF or TIF-related activities, were included in three banks’ CRA reports:
[Bank 1] FNB purchased $1 million (100%) of a local bond issue in 1996. The proceeds
of the issue were used to rebuild and extend Hauenstein Road for future commercial development on the City of Huntington’s north side. To date, nine businesses are
expanding their operations and are in the process of hiring new employees, the majority
93 David Swenson and Liesl Eathington, “Do Tax Increment Finance Districts in Iowa Spur Regional Economic
and Demographic Growth?” (Ames: Department of Economics, Iowa State University, June 2002), available at
http://www.cdfa.net/cdfa/cdfaweb.nsf/fbaad5956b2928b086256efa005c5f78/5941edd057950c37862573d80
056a1ff/$FILE/Do%20Tax%20Increment%20Finance%20Districts%20in%20Iowa%20Spur%20Growth.pdf.
94 Matthew Maryl, “Refocusing Wisconsin’s TIF System on Urban Redevelopment, Three Reforms” (Madison:
Center on Wisconsin Strategy, March 2005), available at http://www.cows.org/pdf/econdev/tif/rp-tif_2005.
pdf.
95 Oakland Community and Economic Development Agency, “Business Assistance: Redevelopment” (Oakland:
Summer 2009), available at www.business2oakland.com/main/redevelopment.htm.
96 Portland Development Commission, “Funding for PDC,” available at www.pdc.us/about_pdc/pdcfunding.
asp#fundstructure.
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of whom would be considered low- to moderate-income.
[Bank 2] A bank officer serves as a board member for the Sealy Tax Increment Reinvestment Zone, and officers serve on local economic development boards of Directors.
[Bank 3] Purchase of $675,000 of [TIF] bonds used to renovate local, public schools.
Bonds were issued as a part of a city approved empowerment zone, where school renovations were seen as a key aspect of revitalizing the city’s older neighborhoods. …97
97 The excerpts are from three reports by the Office of the Comptroller of the Currency, “Community
Reinvestment Act Performance Evaluation” (Washington, DC: OCC, May 7, 1997; May 3, 2009; and April 23,
2007, respectively). Available from [bank 1]: www.occ.treas.gov/ftp/craeval/aug97/14398.pdf; [bank 2]: www.
occ.gov/ftp/craeval/Jan09/4241.pdf; [bank 3]: www.occ.gov/ftp/craeval/Aug08/23920.pdf.
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I
CHARTER SCHOOL AND
RURAL INVESTMENT PROGRAMS
n addition to TIF, Hope VI, Affordable Housing Programs, the Financial and Technical
Assistance programs, and the Section 8 program, many other programs also support
community economic development. Two sets of these programs are described here, one
supporting charter schools and the other set supporting rural development programs.
1. Credit Enhancement for Charter School Facilities
The Charter School Facilities Credit Enhancement program began in 2001 and is administered by the Office of Innovation and Improvement within the U.S. Department of Education.
According to a recent report, the program:
[P]rovides assistance to help charter schools meet their facility needs. Under this
program, funds are provided on a competitive basis to public and nonprofit entities, and
consortia of those entities, to leverage other funds and help charter schools obtain school
facilities through such means as purchase, lease, and donation. Grantees may also use
grants to leverage funds to help charter schools construct and renovate school facilities….
To help leverage funds for charter school facilities, grant recipients may, among other
things, guarantee and insure debt to finance charter school facilities; guarantee and insure
leases for personal and real property; facilitate a charter school's facilities financing by
identifying potential lending sources, encouraging private lending, and other similar
activities; and establish charter school facility "incubator" housing that new charter
schools may use until they can acquire a facility on their own.98
How the Program Works
Charter management organizations, foundations, banks, and nonbank financial institutions
can apply for allocations of funds from the program. The funds are used to finance charter school
facilities throughout the country. As the Department of Education describes the program:
The applications for grants are reviewed based on a numerical scoring system by grant
readers external to the Department. Applicants are awarded extra points for their applications by serving communities with the greatest need for public school choice, which
are typically those communities where the existing public schools are not performing
well and large proportions of students come from low-income families….
98 U.S. Department of Education, “Credit Enhancement for Charter School Facilities” (Washington, DC:
DOE, Office of Innovation and Improvement, February 17, 2009), available at www.ed.gov/programs/
charterfacilities/index.html.
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The grant funds are usually drawn down in full in a one-time payment in advance of
using them and may be invested…grant funds grow over time (i.e., through compounding
interest) if the costs incurred, such as defaults on debt guaranteed through the grant, are
less than the earnings on the investments. However, the program is subject to annual
appropriations from the Department of Education and total grant dollars diminished
substantially between 2007 and 2008 (from $36.5MM awarded in 2007 to $8.3MM
awarded in 2008).99
Community Reinvestment Act Implications
The federal banking regulatory agencies have not issued specific guidance on this program’s
implications related to the Community Reinvestment Act (CRA). However, because charter
schools are often located in low- and moderate-income neighborhoods and serve low- and
moderate-income students, banks providing financing should be eligible for CRA credit. The
following statements from two banks’ CRA reports reference charter school finance activities:
[Bank 1] The bank issued a $250,000 line of credit to fund capital improvements for a charter
school building. The charter school is located in an economically distressed area of Wilmington and 85 percent of the charter school’s students live below the poverty line and 65
percent come from single parent families. This line of credit will help stabilize this area.100
[Bank 2] On May 25, 2006, ANB originated a loan totaling $2.5 million for a charter
school located in a moderate CT [census tract]. The school was built to meet the needs
of the growing Hispanic population by teaching English which is a key factor in future
employment and economic achievement. On October 4, 2007, the bank increased the
amount of the loan by $250 thousand and then, on December 20, 2007, ANB also originated a revolving line-of-credit for $200 thousand.101
2. USDA Housing Programs
The U.S. Department of Agriculture administers several substantial rural housing programs,
including the Farm Labor Housing (Section 514), Rural Rental Housing Guaranteed Loan
Program (Section 538), Rural Rental Housing (Section 515), and Single Family Housing Loan
Guarantees (Section 502). These programs provide loans and guarantees to aid in the development, home purchase, and project financing of single-family and multifamily affordable
housing in rural communities.102
99 Jonathan Kivell, “Paying for School: An Overview of Charter School Finance,” (San Francisco: Federal Reserve
Bank of San Francisco, Community Development Investment Center, August 2008), p. 37, available at www.
frbsf.org/publications/community/wpapers/2008/wp08-03.pdf.
100 Federal Deposit Insurance Corporation, “Community Reinvestment Act Performance Evaluation”
(Washington, DC: FDIC, March 27, 2006), p. 5, available at www2.fdic.gov/crapes/2006/57203_060327.pdf.
101 Office of the Comptroller of the Currency, “Community Reinvestment Act Performance Evaluation”
(Washington, DC: OCC, November 18, 2008), p. 11, available at ww.occ.gov/ftp/craeval/Apr09/16720.pdf.
102 U.S. Department of Agriculture, “Developer Opportunities, Rural Development Housing and Community
Facilities Programs,” (Washington, DC: USGA), available at www.rurdev.usda.gov/rhs/mfh/dev_splash.htm.
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How the Programs Work
Table 1 lists the rural housing programs, their characteristics, and rules of implementation.
Table 1. USDA Rural Development Programs
Program
Name
Formal
Title
Type
Implementation
Farm Labor
Housing
Section
514
Direct loan for
project finance
for farm
laborers (urban
or rural)
“[O]nly nationwide program designed to
provide housing for farm laborers.”
“Funds can be used to purchase a site or
a leasehold interest in a site; to construct
housing, day care facilities, or community
rooms; to pay fees to purchase durable
household furnishings; and to pay
construction loan interest.”
Source: U.S. Department of Agriculture, “Developer
Opportunities, Rural Development Housing and
Community Facilities Programs,” available at www.
rurdev.usda.gov/rhs/mfh/dev_splash.htm.
Rural Rental
Housing
Guaranteed
Loan
Program
Section
538
Guarantees for
project finance
for rural rental
housing
“Loan guarantees are provided for the
construction, acquisition, or rehabilitation of
rural multi-family housing.”
“The terms of the loans guaranteed may be
up to 40 years, and the loans must be fully
amortized.”
Source: U.S. Department of Agriculture, “Guaranteed Rental Housing Program, Rural Development
Housing and Community Facilities Programs,” available at www.rurdev.usda.gov/rhs/mfh/brief_mfh_
grrh.htm.
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Rural Rental
Housing
Section
515
Direct loan for
project finance
for rural rental
housing
“Loans are direct, competitive mortgage
loans made to provide affordable
multifamily rental housing for very low-,
low-, and moderate-income families; the
elderly; and persons with disabilities. This is
primarily a direct mortgage program, but its
funds may also be used to buy and improve
land and to provide necessary facilities such
as water and waste disposal systems.”
“Tenancy: Very low-, low-, and moderateincome families; the elderly; and persons
with disabilities are eligible for tenancy
of Section 515-financed housing...Those
living in substandard housing are given first
priority for tenancy. When rental assistance
is used top priority is given to very lowincome households.”
Source: U.S. Department of Agriculture, “Rural Rental
Housing Loans, Rural Development Housing and
Community Facilities Programs,” available at www.
rurdev.usda.gov/rhs/mfh/brief_mfh_rrh.htm.
Family
Housing
Loan
Guarantees
Section
502
Loan guaranty
program to aid
the purchase
of for-sale
housing by
low- and
moderateincome
homebuyers in
rural areas
“[U]sed to help low-income individuals or
households purchase homes in rural areas.
Funds can be used to build, repair, renovate
or relocate a home, or to purchase and
prepare sites, including providing water and
sewage facilities.”
“Applicants for loans may have an income
of up to 115% of the median income for the
area.”
Source: U.S. Department of Agriculture, “Single
Family Housing Loan Guarantees (Section 502), Rural
Development Housing and Community Facilities
Programs,” available at www.rurdev.usda.gov/rhs/
sfh/brief_rhguar.htm.
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Supporting Community Reinvestment Act Objectives
As one Office of the Comptroller of the Currency publication stated, “Agriculture’s [USDA]
Rural Development has created private market financing programs to help low- and moderateincome rural residents obtain safe and affordable housing. Rural areas are defined as open
country and communities with populations of 10,000 or less. Towns and cities with populations between 10,000 and 25,000 may also be considered as rural, under certain conditions.”103
However, the federal banking regulatory agencies have not issued CRA-specific guidance on the
implications of participating in this program. Because rural and farm worker housing may serve
low- and moderate-income communities, tenants, and homeowners, banks providing financing
would be eligible for CRA credit. In describing the 502 program specifically, the same OCC
publication stated, “Participating lenders may be eligible for favorable consideration under the
Community Reinvestment Act (CRA).”
Further, the following examples were included in the CRA reports by three banks:
[Bank 1] The bank also offers the USDA Rural Development Guaranteed Single Family
Housing Program. Eligible homebuyers must meet certain income restrictions. This
program provides 100 percent financing, requires no down payment, and mortgage
insurance is prohibited.
[Bank 2] SFNB did not offer innovative loan programs during the evaluation period.
However, the bank did offer flexible loan programs for home mortgage loans (Federal
Housing Administration (FHA), Veterans’ Administration (VA), and Farm Service
Agency/Rural Housing Service (FSA/RHS loans). During the evaluation period, SFNB
originated 586 FHA loans totaling $57.8 million. The bank originated 122 VA loans
totaling $14.4 million. SFNB originated 27 FSA/RHS loans totaling $2.7 million. These
flexible loan programs offer borrowers an opportunity to obtain financing when they
would otherwise be denied under conventional loan programs.
[Bank 3] The bank offers a wide variety of loan and deposit products. Products and
services include low cost checking, competitive rate school district incentive accounts
(Academic Prime), USDA Rural Housing, ADFA Home-to-Own program, and an
in-house low- to moderate-income financing program. All programs are available at all
full-service branches while paying and receiving services are available at all the deposit-
103 Office of the Comptroller of the Currency, “USDA Rural Housing Fact Sheet.” Community Developments
Facts Sheet (Washington, DC: OCC, June 2009), p. 1, available at www.occ.treas.gov/Cdd/USDA%20Rural%20
Housing%20Fact%20Sheet.pdf.
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List of Banks with Assets between 1 billion and 10 billion dollars
and a CRA and Investment Test Score of “Outstanding.”
Only the most recent examination of a given bank from 2003 through 2008 is noted
* indicates an exam method other than “Large Bank”
State
Bank
Assets
(in
millions)
CA
Farmers and Merchants Bank of
Central California
1450
California Savings Bank
CT
DE
FL
IA
IL
Exam
Year
Agency
City
2007
FDIC
Lodi
1200
2006
OTS
San Francisco
Greater Bay Bank, N.A.
6880
2006
OCC
Palo Alto
Mellon 1st Business Bank
3168
2006
OCC
Los Angeles
San Diego National Bank
2356
2006
OCC
San Diego
California Commerce Bank
1874
2005
FDIC
Century City
California National Bank
3181
2005
OCC
Los Angeles
County Bank
1353
2005
FRB
Merced
Valley Indep. Bank
1285
2003
FRB
El Centro
Liberty Bank
2648
2008
FDIC
Mddletown
Citizens Bank of Connecticut
3329
2004
FDIC
New London
Wachovia Bank of Delaware
4784
2006
OCC
Wilmington
Wilmington Savings Fund Society
2696
2005
OTS
Wilmington
Citizens Bank
1177
2004
FDIC
Wilmington
PNC Bank, Delaware
2537
2004
FDIC
Wilmington
Commercebank, N.A.
5038
2007
OCC
Coral Gables
Mellon United National Bank
2762
2007
OCC
Miami
City National Bank of Florida
2747
2006
OCC
Miami
Fidelity Federal Bank & Trust
4379
2006
OTS
West Palm
Beach
Republic Bank
2591
2003
FDIC
St. Petersburg
Bankers Trust Company, N.A.
2002
2007
OCC
Des Moines
Hills Bank and Trust Company
1366
2006
FDIC
Hills
Cole Taylor Bank
3292
2007
FRB
Chicago
Shorebank
1897
2007
FDIC
Chicago
First Midwest Bank
7174
2006
FRB
Itasca
Marquette Bank
1338
2006
FRB
Chicago
MB Financial Bank, N.A.
7461
2006
OCC
Chicago
Busey Bank
1781
2005
FDIC
Urbana
Pullman B&TC
1141
2004
FRB
Chicago
Regency Savings Bank, FSB
1354
2004
OTS
Naperville
54
Current Name/
Owner
(Citibank)
(Mercantil
Commercebank)
CRA INVESTMENT HANDBOOK
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LA
Whitney Bank
6981
2003
OCC
New Orleans
MA
Rockland Trust Company
2674
2008
FDIC
Rockland
Bristol County Savings Bank
1041
2007
FDIC
Taunton
Middlesex Savings Bank
3403
2007
FDIC
Natick
Berkshire Bank
2037
2006
FDIC
Pittsfield
Brookline Bank
2075
2006
OTS
Brookline
Boston Private Bank & Trust
Company
1810
2005
FDIC
Boston
Peoplesbank
1061
2005
FDIC
Holyoke
Boston Federal Savings Bank
1684
2004
OTS
Burlington
Eastern Bank
4715
2004
FDIC
Boston
ME
Bangor Savings Bank
1846
2006
FDIC
Bangor
MI
Citizens Bank
5761
2005
FRB
Flint
Citizens First Savings Bank
1271
2005
FDIC
Port Huron
MN
Bremer Bank, N.A.
1620
2005
OCC
South St. Paul
MO
Southwest Bank
2700
2005
FRB
Saint Louis
MT
First Interstate Bank
4907
2007
FRB
Billings
NE
Pinnacle Bank
1826
2006
FDIC
Lincoln
NH
Citizens Bank New Hampshire
7326
2004
FDIC
Manchester
NJ
Columbia Bank
4094
2007
OTS
Fair Lawn
Commerce Bank/North
4017
2006
FDIC
Ramsey
Spencer Savings Bank, SLA
1784
2006
OTS
Elmwood Park
Susquehanna Patriot Bank
2114
2006
FRB
Marlton
Lakeland Bank
1672
2005
FDIC
Newfoundland
NM
Vectra Bank Colorado, N.A.
2589
2006
OCC
Farmington
NV
Nevada State Bank
3886
2008
FDIC
Las Vegas
USAA Savings Bank
7297
2005
FDIC
Las Vegas
Citibank (Nevada), N.A.*
7100
2003
OCC
Las Vegas
Tompkins Trust Company
1133
2008
FDIC
Ithaca
Five Star Bank
1902
2007
FRB
Warsaw
Banco Popular North America
6310
2005
FRB
New York
NBT Bank, N.A.
1512
2004
OCC
Norwich
Union Savings Bank
1661
2007
OTS
Cincinnati
NY
OH
Peoples Bank, N.A.
1865
2006
OCC
Marietta
OK
First United Bank and Trust Co.
1295
2005
FDIC
Durant
PA
Wilmington Trust of Pennsylvania
1180
2007
FRB
Villanova
Dollar Bank, FSB
5231
2007
OTS
Pittsburgh
Lafayette Ambassador Bank
1252
2006
FRB
Easton
Waypoint Bank
5300
2004
OTS
Harrisburg
55
(TD Banknorth)
(Sovereign Bank)
CRA INVESTMENT HANDBOOK
Federal Reserve Bank of San Francisco
PR
R-G Premier Bank of Puerto Rico
7767
2008
FDIC
Hato Rey
SC
Carolina First Bank
8712
2007
FDIC
Greenville
First Citizens Bank and Trust
Company, Inc.
5431
2006
FDIC
Columbia
Home Federal Bank of Tennessee
1719
2007
OTS
Knoxville
First Bank
1157
2005
FDIC
Lexington
Sterling Bank
3626
2006
FDIC
Houston
Amarillo National Bank
1902
2005
OCC
Amarillo
Texas State Bank
3832
2003
FRB
McAllen
TN
TX
Southwest Bank of Texas, N.A.
5160
2003
OCC
Houston
UT
Zions First National Bank
8000
2003
OCC
Salt Lake City
VA
Towne Bank
2274
2007
FDIC
Portsmouth
Riggs Bank, N.A.
6587
2003
OCC
McLean
VT
Chittenden Trust Company
3369
2006
FDIC
Burlington
WA
Homestreet Bank
2412
2007
FDIC
Seattle
Yakima FS & LA
1315
2006
OTS
Yakima
WI
Johnson Bank
3010
2006
FRB
Racine
WV
Wesbanco Bank
4045
2007
FRB
Wheeling
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Community Reinvestment Act:
Interagency Questions and Answers
Regarding Community Reinvestment
Excerpts Pertaining to “Qualified Investments”
January 6, 2009
§ll.12(h)–6: Must there be some immediate or direct benefit to the institution’s assessment
area(s) to satisfy the regulations’ requirement that qualified investments and community
development loans or services benefit an institution’s assessment area(s) or a broader
statewide or regional area that includes the institution’s assessment area(s)?
A6. No. The regulations recognize that community development organizations and programs are efficient and effective ways for institutions to promote community development.
These organizations and programs often operate on a statewide or even multistate basis.
Therefore, an institution’s activity is considered a community development loan or service
or a qualified investment if it supports an organization or activity that covers an area that is
larger than, but includes, the institution’s assessment area(s). The institution’s assessment
area(s) need not receive an immediate or direct benefit from the institution’s specific participation in the broader organization or activity, provided that the purpose, mandate, or
function of the organization or activity includes serving geographies or individuals located
within the institution’s assessment area(s). In addition, a retail institution that, considering
its performance context, has adequately addressed the community development needs of
its assessment area(s) will receive consideration for certain other community development
activities. These community development activities must benefit geographies or individuals located somewhere within a broader statewide or regional area that includes the
institution’s assessment area(s). Examiners will consider these activities even if they will not
benefit the institution’s assessment area(s).
§ll.12(h)–7: What is meant by the term ‘‘regional area’’?
A7. A ‘‘regional area’’ may be as large as a multistate area. For example, the ‘‘mid-Atlantic
states’’ may comprise a regional area. Community development loans and services and
qualified investments to statewide or regional organizations that have a bona fide purpose,
mandate, or function that includes serving the geographies or individuals within the institution’s assessment area(s) will be considered as addressing assessment area needs. When
examiners evaluate community development loans and services and qualified investments
that benefit a regional area that includes the institution’s assessment area(s), they will consider the institution’s performance context as well as the size of the regional area and the
actual or potential benefit to the institution’s assessment area(s). With larger regional areas,
benefit to the institution’s assessment area(s) may be diffused and, thus, less responsive to
assessment area needs. In addition, as long as an institution has adequately addressed the
community development needs of its assessment area(s), it will also receive consideration
for community development activities that benefit geographies or individuals located
somewhere within the broader statewide or regional area that includes the institution’s as-
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sessment area(s), even if those activities do not benefit its assessment area(s).
§ll.12(h)–8: What is meant by the term ‘‘primary purpose’’ as that term is used to define
what constitutes a community development loan, a qualified investment or a community
development service?
A8. A loan, investment or service has as its primary purpose community development
when it is designed for the express purpose of revitalizing or stabilizing low- or moderateincome areas, designated disaster areas, or underserved or distressed nonmetropolitan
middle-income areas, providing affordable housing for, or community services targeted
to, low- or moderate-income persons, or promoting economic development by financing
small businesses and farms that meet the requirements set forth in 12 CFR ll.12(g). To determine whether an activity is designed for an express community development purpose,
the agencies apply one of two approaches. First, if a majority of the dollars or beneficiaries
of the activity are identifiable to one or more of the enumerated community development
purposes, then the activity will be considered to possess the requisite primary purpose.
Alternatively, where the measurable portion of any benefit bestowed or dollars applied to
the community development purpose is less than a majority of the entire activity’s benefits
or dollar value, then the activity may still be considered to possess the requisite primary
purpose if (1) The express, bona fide intent of the activity, as stated, for example, in a prospectus, loan proposal, or community action plan, is primarily one or more of the enumerated community development structured (given any relevant market or legal constraints or
performance context factors) to achieve the expressed community development purpose;
and (3) the activity accomplishes, or is reasonably certain to accomplish, the community
development purpose involved. The fact that an activity provides indirect or short-term
benefits to low- or moderate-income persons does not make the activity community development, nor does the mere presence of such indirect or short-term benefits constitute a
primary purpose of community development. Financial institutions that want examiners to
consider certain activities under either approach should be prepared to demonstrate the
activities’ qualifications.
§ll.12(t)–2: Are mortgage-backed securities or municipal bonds ‘‘qualified investments’’?
A2. As a general rule, mortgage-backed securities and municipal bonds are not qualified
investments because they do not have as their primary purpose community development,
as defined in the CRA regulations. Nonetheless, mortgage-backed securities or municipal
bonds designed primarily to finance community development generally are qualified
investments. Municipal bonds or other securities with a primary purpose of community
development need not be housing related. For example, a bond to fund a community
facility or park or to provide sewage services as part of a plan to redevelop a low-income
neighborhood is a qualified investment. Certain municipal bonds in underserved nonmetropolitan middle-income geographies may also be qualified investments. See Q&A §ll.12(g)
(4)(iii)–4. Housing-related bonds or securities must primarily address affordable housing
(including multifamily rental housing) needs of low- or moderate-income individuals in
order to qualify. See also Q&A §ll.23(b)–2.
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§ll.12(t)–3: Are Federal Home Loan Bank stocks or unpaid dividends and membership
reserves with the Federal Reserve Banks ‘‘qualified investments’’?
A3. No. Federal Home Loan Bank (FHLB) stocks or unpaid dividends, and membership
reserves with the Federal Reserve Banks do not have a sufficient connection to community
development to be qualified investments. However, FHLB member institutions may receive
CRA consideration as a community development service for technical assistance they provide on behalf of applicants and recipients of funding from the FHLB’s Affordable Housing
Program. See Q&A §ll.12(i)–3.
§ll.12(t)–4: What are examples of qualified investments?
A4. Examples of qualified investments include, but are not limited to, investments, grants,
deposits, or shares in or to:
• Financial intermediaries (including Community Development Financial Institutions
(CDFIs), New Markets Tax Credit-eligible Community Development Entities, Community
Development Corporations (CDCs), minority- and women-owned financial institutions
community loan funds, and low-income or community development credit unions) that
primarily lend or facilitate lending in low- and moderate-income areas or to low- and
moderate-income individuals in order to promote community development, such as a
CDFI that promotes economic development on an Indian reservation; • Organizations engaged in affordable housing rehabilitation and construction, including multifamily rental
housing; • Organizations, including, for example, Small Business Investment Companies
(SBICs), specialized SBICs, and Rural Business Investment Companies (RBICs) that promote
economic development by financing small businesses; • Community development venture
capital companies that promote economic development by financing small businesses; •
Facilities that promote community development by providing community services for lowand moderate-income individuals, such as youth programs, homeless centers, soup kitchens, health care facilities, battered women’s centers, and alcohol and drug recovery centers;
• Projects eligible for low-income housing tax credits; • State and municipal obligations,
such as revenue bonds, that specifically support affordable housing or other community
development; • Not-for-profit organizations serving low- and moderate-income housing
or other community development needs, such as counseling for credit, homeownership,
home maintenance, and other financial literacy programs; and • Organizations supporting
activities essential to the capacity of low- and moderate-income individuals or geographies
to utilize credit or to sustain economic development, such as, for example, day care operations and job training programs that enable low- or moderate-income individuals to work.
See also Q&As §ll.12(g)(4)(ii)–2; §ll.12(g)(4)(iii)–3; §ll.12(g)(4)(iii)–4.
§ll.12(t)–5: Will an institution receive consideration for charitable contributions as ‘‘qualified
investments’’?
A5. Yes, provided they have as their primary purpose community development as defined
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in the regulations. A charitable contribution, whether in cash or an in-kind contribution of
property, is included in the term ‘‘grant.’’ A qualified investment is not disqualified because
an institution receives favorable treatment for it (for example, as a tax deduction or credit)
under the Internal Revenue Code.
§ll.12(t)–6: An institution makes or participates in a community development loan. The
institution provided the loan at below-market interest rates or ‘‘bought down’’ the interest
rate to the borrower. Is the lost income resulting from the lower interest rate or buy-down a
qualified investment?
A6. No. The agencies will, however, consider the responsiveness, innovativeness, and complexity of the community development loan within the bounds of safe and sound banking
practices.
§ll.12(t)–7: Will the agencies consider as a qualified investment the wages or other compensation of an employee or director who provides assistance to a community development organization on behalf of the institution?
A7. No. However, the agencies will consider donated labor of employees or directors of a
financial institution as a community development service if the activity meets the regulatory definition of ‘‘community development service.’’
§ll.12(t)–8: When evaluating a qualified investment, what consideration will be given for
prior period investments?
A8. When evaluating an institution’s qualified investment record, examiners will consider
investments that were made prior to the current examination, but that are still outstanding. Qualitative factors will affect the weighting given to both current period and outstanding prior-period qualified investments. For example, a prior-period outstanding investment
with a multi-year impact that addresses assessment area community development needs
may receive more consideration than a current period investment of a comparable amount
that is less responsive to area community development needs.
§ll.23(a)–1: May an institution, regardless of examination type, receive consideration under
the CRA regulations if it invests indirectly through a fund, the purpose of which is community development, as that is defined in the CRA regulations?
A1. Yes, the direct or indirect nature of the qualified investment does not affect whether an
institution will receive consideration under the CRA regulations because the regulations do
not distinguish between ‘‘direct’’ and ‘‘indirect’’ investments. Thus, an institution’s investment in an equity fund that, in turn, invests in projects that, for example, provide affordable housing to low- and moderate-income individuals, would receive consideration as a
qualified investment under the CRA regulations, provided the investment benefits one or
more of the institution’s assessment area(s) or a broader statewide or regional area(s) that
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includes one or more of the institution’s assessment area(s). Similarly, an institution may
receive consideration for a direct qualified investment in a nonprofit organization that, for
example, supports affordable housing for low- and moderate-income individuals in the
institution’s assessment area(s) or a broader statewide or regional area(s) that includes the
institution’s assessment area(s).
§ll.23(a)–2: In order to receive CRA consideration, what information may an institution
provide that would demonstrate that an investment in a nationwide fund with a primary
purpose of community development will directly or indirectly benefit one or more of the
institution’s assessment area(s) or a broader statewide or regional area that includes the
institution’s assessment area(s)?
A2. There are several ways to demonstrate that the institution’s investment in a nationwide
fund meets the geographic requirements, and the agencies will employ appropriate flexibility in this regard in reviewing information the institution provides that reasonably supports this determination. As an initial matter, in making this determination, the agencies
would consider whether the purpose, mandate, or function of the fund includes serving
geographies or individuals located within the institution’s assessment area(s) or a broader
statewide or regional area that includes the institution’s assessment area(s). Typically,
information about where a fund’s investments are expected to be made or targeted will
be found in the fund’s prospectus, or other documents provided by the fund prior to or at
the time of the institution’s investment, and the institution, at its option, may provide such
documentation in connection with its CRA evaluation. At the institution’s option, written
documentation provided by fund managers in connection with the institution’s investment
indicating that the fund will use its best efforts to invest in a qualifying activity that meets
the institution’s geographic requirements also may be used for these purposes. Similarly,
at the institution’s option, information that a fund has explicitly earmarked its projects or
investments to its investors and their specific assessment area(s) or broader statewide or
regional areas that include the assessment area(s) also may be used for these purposes. (If
any documentation that has been provided at the institution’s option as described above
clearly indicates that the fund ‘‘double-counts’’ investments, by earmarking the same dollars or the same portions of projects or investments in a particular geography to more than
one investor, the investment may be determined not to meet the geographic requirements
of the CRA regulations.) In addition, at the institution’s option, an allocation method may
be used to permit the institution to claim a pro-rata share of each project of the fund. Nationwide funds are important sources of investments for low- and moderate-income and
underserved communities throughout the country and can be an efficient vehicle for institutions in making qualified investments that help meet community development needs.
Prior to investing in such a fund, an institution should consider reviewing the fund’s investment record to see if it is generally consistent with the institution’s investment goals and
the geographic considerations in the regulations. See also Q&As §ll.12(h)–6 and §ll12(h)–7
(additional information about recognition of investments benefiting an area outside an
institution’s assessment area(s)).
§ll.23(b)–1: Even though the regulations state that an activity that is considered under the
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lending or service tests cannot also be considered under the investment test, may parts of
an activity be considered under one test and other parts be considered under another test?
A1. Yes, in some instances the nature of an activity may make it eligible for consideration
under more than one of the performance tests. For example, certain investments and
related support provided by a large retail institution to a CDC may be evaluated under the
lending, investment, and service tests. Under the service test, the institution may receive
consideration for any community development services that it provides to the CDC, such
as service by an executive of the institution on the CDC’s board of directors. If the institution makes an investment in the CDC that the CDC uses to make community development
loans, the institution may receive consideration under the lending test for its pro-rata share
of community development loans made by the CDC. Alternatively, the institution’s investment may be considered under the investment test, assuming it is a qualified investment.
In addition, an institution may elect to have a part of its investment considered under the
lending test and the remaining part considered under the investment test. If the investing institution opts to have a portion of its investment evaluated under the lending test
by claiming its pro rata share of the CDC’s community development loans, the amount of
investment considered under the investment test will be offset by that portion. Thus, the
institution would receive consideration under the investment test for only the amount of
its investment multiplied by the percentage of the CDC’s assets that meet the definition of
a qualified investment.
§ll.23(b)–2: If home mortgage loans to low- and moderate-income borrowers have been
considered under an institution’s lending test, may the institution that originated or purchased them also receive consideration under the investment test if it subsequently purchases mortgage-backed securities that are primarily or exclusively backed by such loans?
A2. No. Because the institution received lending test consideration for the loans that
underlie the securities, the institution may not also receive consideration under the investment test for its purchase of the securities. Of course, an institution may receive investment
test consideration for purchases of mortgage-backed securities that are backed by loans to
low- and moderate-income individuals as long as the securities are not backed primarily or
exclusively by loans that the same institution originated or purchased.
§ll.23(e)–1: When applying the four performance criteria of 12 CFR ll.23(e), may an examiner distinguish among qualified investments based on how much of the investment actually
supports the underlying community development purpose?
A1. Yes. By applying all the criteria, a qualified investment of a lower dollar amount may be
weighed more heavily under the investment test than a qualified investment with a higher
dollar amount that has fewer qualitative enhancements. The criteria permit an examiner to
qualitatively weight certain investments differently or to make other appropriate distinctions when evaluating an institution’s record of making qualified investments. For instance,
an examiner should take into account that a targeted mortgage-backed security that
qualifies as an affordable housing issue that has only 60 percent of its face value supported
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by loans to low- or moderate-income borrowers would not provide as much affordable
housing for low- and moderate-income individuals as a targeted mortgage-backed security with 100 percent of its face value supported by affordable housing loans to low- and
moderate-income borrowers. The examiner should describe any differential weighting (or
other adjustment), and its basis in the Performance Evaluation. See also Q&A §ll.12(t)–8 for
a discussion about the qualitative consideration of prior period investments.
§ll.23(e)–2: How do examiners evaluate an institution’s qualified investment in a fund, the
primary purpose of which is community development, as defined in the CRA regulations?
A2. When evaluating qualified investments that benefit an institution’s assessment area(s)
or a broader statewide or regional area that includes its assessment area(s), examiners will
look at the following four performance criteria: (1) The dollar amount of qualified investments; (2) The innovativeness or complexity of qualified investments; (3) The responsiveness of qualified investments to credit and community development needs; and (4) The
degree to which the qualified investments are not routinely provided by private investors.
With respect to the first criterion, examiners will determine the dollar amount of qualified
investments by relying on the figures recorded by the institution according to generally
accepted accounting principles (GAAP). Although institutions may exercise a range of
investment strategies, including short-term investments, long-term investments, investments that are immediately funded, and investments with a binding, up-front commitment that are funded over a period of time, institutions making the same dollar amount
of investments over the same number of years, all other performance criteria being equal,
would receive the same level of consideration. Examiners will include both new and
outstanding investments in this determination. The dollar amount of qualified investments also will include the dollar amount of legally binding commitments recorded by the
institution according to GAAP. The extent to which qualified investments receive consideration, however, depends on how examiners evaluate the investments under the remaining
three performance criteria—innovativeness and complexity, responsiveness, and degree
to which the investment is not routinely provided by private investors. Examiners also will
consider factors relevant to the institution’s CRA performance context, such as the effect of
outstanding long-term qualified investments, the pay-in schedule, and the amount of any
cash call, on the capacity of the institution to make new investments.
§ll.26–1: When evaluating a small or intermediate small institution’s performance, will
examiners consider, at the institution’s request, retail and community development loans
originated or purchased by affiliates, qualified investments made by affiliates, or community development services provided by affiliates?
A1. Yes. However, a small institution that elects to have examiners consider affiliate activities must maintain sufficient information that the examiners may evaluate these activities
under the appropriate performance criteria and ensure that the activities are not claimed
by another institution. The constraints applicable to affiliate activities claimed by large
institutions also apply to small and intermediate small institutions. See Q&As addressing 12
CFR ll.22(c)(2) and related guidance provided to large institutions regarding affiliate activi-
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ties. Examiners will not include affiliate lending in calculating the percentage of loans and,
as appropriate, other lending-related activities located in an institution’s assessment area.
§ll.26(b)–5: Under the small institution lending test performance standards, how will qualified investments be considered for purposes of determining whether a small institution
receives a satisfactory CRA rating?
A5. The small institution lending test performance standards focus on lending and other
lending-related activities. Therefore, examiners will consider only lending-related qualified investments for the purpose of determining whether a small institution that is not an
intermediate small institution receives a satisfactory CRA rating.
§ll.26(c)–1: How will the community development test be applied flexibly for intermediate
small institutions?
A1. Generally, intermediate small institutions engage in a combination of community
development loans, qualified investments, and community development services. An
institution may not simply ignore one or more of these categories of community development, nor do the regulations prescribe a required threshold for community development
loans, qualified investments, and community development services. Instead, based on the
institution’s assessment of community development needs in its assessment area(s), it may
engage in different categories of community development activities that are responsive to
those needs and consistent with the institution’s capacity. An intermediate small institution
has the flexibility to allocate its resources among community development loans,
§ll.26(d)–2: Will a small institution’s qualified investments, community development loans,
and community development services be considered if they do not directly benefit its assessment area(s)?
A2. Yes. These activities are eligible for consideration if they benefit a broader statewide or
regional area that includes a small institution’s assessment area(s), as discussed more fully
in Q&As §ll.12(h)–6 and §ll.12(h)–7.
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Additional copies are available upon request from the Community Development Department, Federal Reserve Bank of San
Francisco, 101 Market Street, San Francisco, California 94105, or
call (415) 974-3467.
The views expressed are not necessarily those of the Federal
Reserve Bank of San Francisco or the Federal Reserve System.
Material herein may be reprinted or abstracted as long as the
CRA Investment Handbook is credited.
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